By: Investor Solutions, Inc.
Every year millions of U.S. taxpayers get very creative with the types of tax deductions they chose to list on their Federal Income Tax Return. Many of the deductions used are legitimate, some are questionable, and others the IRS would find outright humorous. So how do you minimize your chance of a tax audit and avoid the possibility of a tax fine or even some “jail time”? It’s ultimately your responsibility to verify your earned income reported to the IRS and research the deductions taken to ensure the legitimacy of your return.
In 2003, the Standard Deduction for a single taxpayer is $4,750 and $9,500 for a couple married filing jointly (an additional deduction is available if your age 65 or older or blind). For those of you with deductions that exceed the standard deduction limits, you will most likely itemize your deductions, and this is the area that must receive special attention. Itemizing your deductions is possibly the most abused area when it comes to taking “bogus” deductions.
The IRS does not have the personnel or the resources to examine every tax return, so it selects those returns that have “high audit potential”, basically those returns most likely to result in a substantial tax deficiency. Certain professions, transactions reported, and deductions claimed can increase your chance of an audit. Your chances of being audited are greater under the following circumstances:
- Income information on W2 and Form 1099’s doesn’t match
- Itemized Deductions exceed IRS targets
- Claiming tax-shelter losses
- You receive cash payments in your line of work (tips, cash fees received by doctors)
- Prior audit resulted in tax deficiency
- You are a shareholder of a closely held corporation
- Large cash contributions to a charity in relation to income
- Business expenses are large in relation to income
- You report complex investment or business transactions without clear explanations
- The IRS has reason to believe that you are omitting income from your return due to an informer
The IRS has established some internal ranges for itemized deductions; if your itemized deductions exceed these target ranges your chances of being audited will increase. Although there’s no specific criteria published by the IRS that will trigger an automatic audit, average statistics from the past have been released and they can be used as a reliable benchmark to keep your return off the “red flag” list.
Average Itemized Deductions*
|200 or more||35,927||38,931||23,260||17,842|
* IRS figures based on deductions claimed on 2001 returns
To maximize your tax-saving opportunities through itemizing your deductions, you’ll need to keep accurate records throughout the year. Here are some ideas on how to track, improve, and legitimize your tax deductions:
- Use your checkbook stub to keep record of expenses paid
- Keep a calendar or diary of expenses to record deductible items
- Make it a habit to write down deductible items as they come along
- Keep a file of bills & receipts. This can be an ordinary folder or a set of envelopes labeled for each particular deduction category.
Remember, accurate and detailed record-keeping will not only make it easier to prepare your return, but it will help to reduce errors, provide a more sturdy defense to any IRS challenge, and make your time spent in your accountant’s office much shorter.
So how long should you keep your records and tax returns? In most cases, records should be kept for three years (plus any amendments) after the applicable tax year, the IRS generally has three years from the date your return is filed to audit your return. If it’s a case where income has not been reported, the IRS can go back as many as six years. In cases of suspected tax fraud, there is no time limit at all.
If effective use of all your deductions and avoiding problems with the IRS is important to you, I recommend using an efficient tax software program such as Turbo Tax or Tax Cut. They can both be purchased at local retailers or on the web at www.turbotax.com and www.taxcut.com. Both software packages walk you through all the available deductions, credits, and various tax tips while allowing you to file your return using the “e-file” service available with the IRS. Remember, April 15, 2004 is the deadline for filing your 2003 Federal Return (unless you receive a filing extension). Although the odds are low that your return will be picked for an audit, it’s important that you properly research all your deductions taken, or consult a tax professional if you are questionable on the validity of any particular deduction or tax credit. In my next article, I’ll cover some of the new deductions, common deduction misconceptions, and other tax changes for 2003. Happy Filing!