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10 Ways to Avoid a Tax Audit
By BARBARA WELTMAN
Worried about extra scrutiny from the Internal Revenue Service?
While you can never completely "audit-proof" your business's income tax return, you can take actions that will greatly reduce your chances of being flagged.
Here are 10 ways to avoid a tax audit:
1. Choose your tax return preparer with care. Today, according to the recent National Taxpayer Advocate report, 60% of individuals and even a greater percentage of businesses use paid preparers to do their income tax returns. Yet, preparers now face more intense IRS review. If the IRS believes a preparer is claiming unwarranted deductions or taking other fraudulent steps on clients' returns, then the preparer's clients are at risk for audit.
The IRS has eight tips for choosing a tax preparer. Key among them is to check the preparer's history to see if there has been any disciplinary action. For example, if you use an enrolled agent, check with the IRS' office of Professional Responsibility at email@example.com (include the preparer's name and address).
2. Report all of your income. The IRS uses information returns, such as W-2s and 1099s, to cross-check income reporting. Under its document-matching program, the IRS' computers compare information on the forms with the income reported by taxpayers on their returns. If the information doesn't match, this leads to an automatic audit. But don't panic; it's merely a correspondence asking about the discrepancy. It can be easily cleared up by submitting an explanation by mail if you think you are correct, or paying the tax owed if the omission was your oversight and the IRS is correct.
Sole proprietors, freelancers and independent contractors who use the cash method of accounting may be vulnerable to year-end payment problems. For instance, a sole proprietor that performed work for a client may have received a payment in early January – but the client might have mailed (and recorded) the payment in December. The client will include the payment on Form 1099-MISC for 2010, but it isn't taxable until 2011. What to do: Include the payment as it is reported on the 2010 return, but then subtract the payment and attach an explanation with the return. Then include the payment on the 2011 return, even though no 1099 will be issued for this year.
3. Provide complete information. All questions should be answered and all required information should be included on the forms and schedules necessary for your return. That means if you're a sole proprietor, include your business code number, accounting method, and, where applicable, inventory valuation method on Schedule C. If information is missing, it could trigger a more extensive look at the return.
Also add information where necessary to explain entries or omissions that are not easily understood—such as in the prior example, when income received in January is reported on a prior year 1099.
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About the Author
Barbara Weltman is an attorney who has written several books, including "J.K. Lasser's Small Business Taxes" and "The Complete Idiot's Guide to Starting a Home-Based Business." She publishes "Idea of the Day" and monthly e-newsletter "Big Ideas for Small Business" at www.barbaraweltman.com, and hosts the "Build Your Business" radio show