5 Common Tax Mistakes We Need to Stop Making

By Damian Davila on 18 January 2017 0 comments

In an ongoing effort to prevent tax fraud and collect the right amount of money, the IRS audits close to 1% of all returns. If being audited by the IRS isn't nerve racking enough, about 30% of audits are made in person, adding extra pressure. So, let's start 2017 on the right foot and review five ways to protect yourself from an audit.

1. Declare at Least $1 in Gross Income

Depending on your unique financial situation, you may not have gained any money throughout the year. However, declaring no adjusted gross income increases your probability of getting audited by more than fivefold! In 2014, the IRS audited 5.26% of all returns with no adjusted gross income. On the other hand, the IRS only audited 0.93% of returns declaring $1 to $24,999 in the same year.

So, find a way to get some income and dramatically lower your chances of an audit!

2. Use an Accountant When Making Over $200,000

According to 2014 and 2015 IRS audit data, returns with gross incomes between $25,000 and $199,999 have the lowest range of probability of an audit.

Like a Las Vegas casino, the IRS is currently chasing the "whales" — individuals with a high net worth. In 2014, 1.75% of returns with an unadjusted gross income of $200,000 to $499,999, and, get this — a whopping 10.53% of those with an adjusted gross income of $5 to $10 million, were audited. It seems that there's some truth to "more money, more problems." So, if you're making a gross income of $200,000 or higher, hedge against the higher chances of potential IRS audit by using the services of an accountant. (See also: 4 Times You Should Splurge and Hire a Pro)

3. Include Income From All W-2s and 1099s

The IRS gets a copy of every single W-2 and 1099 form that you receive. So, forgetting to include the income reported on those forms to calculate your tax obligation or refund may result in an audit.

While it's generally easy to trace back your W-2s, keep in mind that there are different types of 1099 forms, including:

  • 1099-C: Cancellation of Debt, which is sometimes a taxable event;
     
  • 1099-DIV: Dividend and Distribution Income;
     
  • 1099-H: Health Coverage Tax Credit (HCTC) advance payments;
     
  • 1099-INT: Interest Income;
     
  • 1099-MISC: Miscellaneous Income, which are payments to independent contractors; and
     
  • SSA-1099: Social Security Benefit Statement.

You will receive an applicable 1099 form after reaching certain thresholds. For example, you will receive a 1099-MISC when you received at least $600 in payment for your services as a freelancer or independent contractor. On the other hand, you only need to make at least $10 in interest income to receive a 1099-INT. Regardless of whether or not an organization issues you a 1099, include the taxable income in your return.

If you haven't received a 1099 by January 31st, the IRS recommends contacting the issuing organization or the IRS directly at 1-800-829-1040 to request a substitute form.

4. Use Schedule C Correctly

The Schedule C is a form in which sole proprietorships provide details on their calculations of net profit or loss. When used properly, Schedule C allows freelancers, independent contractors, and small business owners to effectively deduct businesses expenses, including expenses for business use of a home (Form 8829).

Taxpayers using Schedule C frequently make intentional or unintentional errors on this form. And the IRS has noted that it can get a better bang for its auditing buck in inspecting the returns of sole proprietorships. The result: Roughly 3% of small businesses under Schedule C get audited, compared to just 1% of corporations. The IRS pays close attention to businesses with large net losses and cash-intensive activities, such as car washes and food vendors.

Make sure that you have supporting documentation, such as receipts, statements of personal and business bank accounts, and inventory count sheets for all the numbers that you include in Schedule C. For example, if you have an advertising expense, keep the bill or receipt as proof of that expense. If the IRS were to have reasonable doubt that your numbers are accurate, the agency would send you a Form 4564, Information Document Request. Be proactive, review this sample Form 4564 from the IRS, and make sure to keep the type of records that the IRS would ask from you in case of an audit due to a Schedule C.

In the end, a taxpayer using Schedule C could benefit from using a professional tax preparer. They can also deduct that expense in their Schedule C, after all.

5. Automate Calculations

Completing your tax return by hand increases your odds of making math errors, miscalculating work sheets, and misreading tables. Just in 2015, the IRS sent out 1,679,367 math error notices to taxpayers for a total of 2,177,802 math errors!

To decrease your chance of computational errors, incorrectly transcribed values, and omitted entries, consider hiring a pro that will double check all the work for you or using a tax preparation software that will do all the calculations for you.

The Bottom Line: Prevent That Audit!

Better safe than sorry. If the IRS notifies you of an audit by phone or mail (no emails!), you are most likely to either have to pay extra or experience no change. In 2015, only 3.33% of examined individual income tax returns resulted in additional refunds to the taxpayer. Take action and use these five ways to prevent common tax mistakes that increase your chances of an IRS audit.

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