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You can minimize your risk of being audited

Created date

April 5th, 2016
IRS conducting a tax audit

IRS conducting a tax audit

When you drop your tax return in the mail (or hit submit on an e-file site), the last thing you want to think about is being the subject of an IRS audit. But, a certain percentage of taxpayers are audited each year, so it’s important to be prepared and know which red flags might draw negative attention to your return.

“The audit rates vary from year to year, and even a perfectly prepared tax return can be audited,” says Dave Du Val, vice president of customer advocacy at TaxAudit.com. “And certain items on your tax return will almost guarantee an audit, such as a Schedule C for a business with no income and high losses.”

Deductions that stand out

Du Val says there are several mistakes that retired taxpayers in particular should avoid to reduce the chance of an audit. High deductions for charitable contributions, for instance, can make a return a target for an audit. Similarly, high gambling losses are also likely to catch an auditor’s eye. Health care costs tend to increase during retirement, but Du Val says a high medical expenses deduction is another red flag.

“A common mistake taxpayers make is reporting all medical expenses billed rather than those paid out of pocket,” he says. “Medical expenses paid by your insurance company are not deductible.”

Also be sure to correctly report all distributions from retirement plans. Money you withdraw from a 401(k) or IRA is taxable income. You must take required minimum distributions by April 1 following the year you turn 70 ½. Du Val says failure to do so triggers a 50% penalty and also raises your risk of being audited.

It is increasingly common for retirees to earn income from so-called “encore careers” and launch their own small businesses. Du Val says to be careful about how you report losses from a new business.

Hobby vs. business

“Many times, a retiree will focus on an activity they may consider a business but that for tax purposes the IRS would consider a hobby—large losses from a hobby are likely to trigger an audit,” he says.

If you do find yourself being audited by the IRS, there are steps you can take to minimize the pain. First and foremost, Larry M. Elkin, president of Palisades Hudson Financial Group (palisadeshudson.com), says you should not represent yourself.

“The audit process works best when it is limited to the issues the auditor raises. Your presence invites incomplete or incorrect off-the-cuff answers,” Elkin says. “An effective taxpayer representative (usually a CPA, attorney, or IRS-authorized enrolled agent) will find out what the auditor wants to know, gather the information and present it clearly and concisely without triggering collateral issues.”

Authorities have three years after you file your return to request information, and complete an audit. Elkin says auditors have heavy caseloads and usually ask taxpayers to waive that three-year limit. You have the right to deny that request.

“Waiving the statute allows the agent to drag out the process, inflating the taxpayer’s cost for representation and increasing potential interest and penalty charges,” he says. “It gives the agent more time to raise more issues. It lets the agent raise additional issues if new legislation, regulations, or court decisions provide support. You get no benefit.”

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