The Internal Revenue Service has stepped up its audits over the past few years. In addition to traditional face-to-face audits, it is also conducting an increasing number of correspondence audits where taxpayers are requested to verify various expenses by mail.
Increasing scrutiny is being given to tax preparers who prepare fraudulent returns. Once a “bad” preparer is discovered, the IRS criminal division, which sports a greater than 95 percent conviction rate, goes after him or her. The audit division then begins auditing all the preparer’s returns looking for repetitive errors.
A favorite area for fraud is the Earned Income Credit, which can be worth thousands of dollars to taxpayers with young children and income under a certain level.
Sometimes couples pretend to be unmarried and have the wife claim the kids while subtracting the husband’s high income from the return in order to qualify for the credit. What most taxpayers don’t realize is that if their preparer is cheating on their return, he is cheating on most of his returns, ensuring that eventually he will be caught.
Those tax preparers receiving a 1099-C for cancellation of debt are being aggressively audited. Many taxpayers neglect to report the income at all. It is possible in some cases to exclude a portion or all of the debt relief due to the Qualified Principal Residence Exclusion, the Qualified Real Property Business Indebtedness Exclusion or Insolvency. The rules are extremely complex and one should submit a paper return with the supporting documentation to confirm you are entitled to the exclusion(s).
If you are claiming mileage, you are required to keep a log showing the business miles and business purpose of the trip. Commute mileage doesn’t count. This is a favorite area of scrutiny for the IRS and it is a stickler for detailed written logs.
Office in the home deductions are questioned most often when someone works as an employee. The office needs to be for the employer’s convenience, not the taxpayer’s. A common question is “would you be fired if you did not have the office in your home?” Written corroboration from the employer is often required.
Many people when they prepare their own returns don’t bother to include sales of stocks or mutual funds. Since the IRS doesn’t know the cost basis, it assumes zero and sends out a letter with a large amount of tax due.
Some taxpayers will fail to report sales because it’s a loss, so the IRS shouldn’t care. However, the IRS doesn’t know it’s a loss. You are also missing out on a tax benefit that could carry over far into the future.
Charitable contributions are now being closely scrutinized and require written backup. Taxpayers with a high level of contributions for their income are sometimes subject to correspondence audits.
Businesses that deal in cash including construction continue to be profitable targets for the audit division. Comparing known and estimated expenses with stated income on the tax return provides the IRS with prospective audit targets.
Your tax preparer should be able to inform you of what records are required and the sensitive areas of your own particular returns.