Despite their reputation, I’m sure IRS agents are very nice people. I’m equally sure that I really don’t want them knocking on my door and asking for my shoebox full of receipts. You might feel the same way.
Unfortunately, there’s no surefire way to avoid an audit, but you can take comfort in knowing that less than 1 percent of taxpayers were audited in 2013. And you can further reduce your odds by avoiding some common mistakes that could trigger a visit from the taxman.
Mistake No. 1: Hiring the wrong tax preparer
The first mistake you could make might occur before you even get your name on the tax return. It’s picking the wrong tax preparer.
Select someone who is incompetent or unethical, and he or she could spell big trouble for you. If the IRS audits one of the returns the tax preparer filed and finds significant problems, the agency could decide to audit all the returns that person prepared for the year, or the past several years.
Don’t make this mistake. Read our advice on how to select the best tax pro.
Mistake No. 2: Saying your hobby is a business
Let’s say you breed and sell dogs, or sell blankets on Etsy, or resell garage sale purchases on eBay. At the end of the year, you realize expenses exceeded what you made and decide to deduct a tax loss from your “business.”
However, do that for three or more years and the IRS is going to get suspicious. A business is something that makes money. If you haven’t made money in three years, you may actually have a hobby. The IRS doesn’t allow business deductions for hobbies.
Mistake No. 3: Filing certain schedules or forms
You might say the third item on our list isn’t a mistake because, in many cases, there is no way to avoid it. For example, if you have a business, you need to file a Schedule C. And yet filing a Schedule C increases your chances of an audit.
However, it would be a mistake to file a Schedule C if you have an unprofitable business that is more like a hobby. It may also be a mistake to file a Form 5213 if you’re not sure.
Form 5213 prevents the IRS from auditing you for the first five years of your business, and it is typically used when transitioning a hobby into a business. It allows you to claim losses from your hobby-turned-business, no questions asked. That is, until the five years are up, and the IRS comes calling to see what you’ve been up to.
Mistake No. 4: Taking questionable deductions or credits
Under the category of questionable deductions, experts say the two that may be most likely to raise red flags are excessive charitable contributions and a home office. Under the category of credits, the Earned Income Tax Credit is most likely to get you in trouble, according to experts.
If you donate a large percentage of your income to charity, be sure to keep careful records. Too many contributions, relative to your income, can be a problem. Of course, you definitely want to claim every deduction to which you’re entitled, but you might want to think twice about inflating the value of those items you dropped off at the thrift store. Keep careful records of all donations and be sure to get a written acknowledgement from any charity to which you donate $250 or more per year.
As for the home office, take the deduction to which you’re entitled, but be ready to defend it if needed. The most important thing to remember is you can only deduct a home office if you use that space exclusively for business. In other words, a communal family desk can’t be considered a home office because it’s used for purposes other than your work.
Finally, back in 2013, the IRS came under fire in a report from the Treasury Inspector General for Tax Administration for not taking enough action to curtail improperly awarded Earned Income Tax Credits. In a statement reported by multiple news outlets (although apparently no longer on the IRS website), the agency fired back by saying EITC claims were twice as likely to be audited as other returns. If you claim the EITC, consider yourself warned.