Avoid audit causing errors when planning taxes
It's never too soon to start planning for your next tax return. Now that your 1997 tax return is behind you (unless you decided to drag out the agony a bit further and filed for an extension), you can start planning your strategy for your 1998 tax return.
Before you get too creative, however, take a look at this list of tax situations that are notorious for attracting the attention of the IRS.
Unexplained deductions. You don't need a glass-bottomed boat to tell that there's something fishy when large deductions appear on the tax return with descriptions like, "Miscellaneous expenses," "Various charities" or "Other expenses." Go ahead and admit that you really donated $4,000 to the Organization to Save the Bembex Wasp. The IRS may think you're crazy, but that's better than having them think you're cheating.
Unreported income . Don't think for a minute that the extra income you earn as a free-lance beekeeper will escape the notice of the taxing authorities. If you receive a 1099 form, you need to report the income on your tax return. For that matter, even if you don't receive a 1099 form you need to report the income that you earned. It's the job of the person who paid you to fill out the 1099 form and send a copy to you and one to the IRS, but it's your job to put the earnings on your tax return, even if the 1099 got lost in the mail. Trust me, the IRS knows about it. They know everything.
Alimony. Whether you pay it or receive it, your participation represents only one-half of the alimony equation. The IRS likes to look at tax returns reporting alimony if for no other reason than to find out who should be deducting or receiving the payments at the other end.
Income too high . Sometimes it may seem like you can never make enough money. And now they're telling you not to make too much? I'd say, go ahead and make all the money you can. But be aware that the higher your income, the more likely it is that your tax return will be selected for audit. It's just the price you have to pay.
Income too low . Too high or too low: which is it? If the income you report on your tax return seems low for the type of work you perform, that too can trigger an audit. Seems kind of strange to me, but I guess you need to ask the boss for a raise because the IRS doesn't think you're making enough money.
Business deductions . Extensive business deductions seem to interest the IRS. Whether you are an employee, or self-employed, business expenses such as travel, entertainment, gifts, and food are of particular interest to the taxing authorities. The higher these types of deductions in relation to your business income, the more likely it is you will start the audit ball rolling. Keep excellent receipts for business expenses, documenting the business nature of the expense in addition to the amount, time, place, what the weather was like, and so on.
Amended returns. We've all been taught that when we make a mistake we should try our best to correct it. And that goes for tax returns too. You have three years from the time your tax return is due to amend the return, correcting errors or including items omitted from the original return. Amended returns do, however, attract a bit of attention. Particularly those claiming refunds (and how many of you amended your tax returns when you discovered you owe additional tax ?). Include complete explanations of the changes you are making on your amended return.
Bad debt deductions. You have the right to take a deduction for loans gone sour, but the IRS is very particular about when these deductions are claimed and whether or not the debt is actually worthless. A claim of a deduction for a bad debt must be triggered by an identifiable event that caused the debt to become worthless. If you simply say you loaned your brother $2,000 about 20 years ago and it doesn't look like you're ever going to see it again, the IRS will question why you are claiming the deduction this year, why not last year or why not wait until next year? If the deduction doesn't belong in any particular year, then it doesn't belong anywhere at all. Why don't you ask your brother to put the fact that he's not going to pay you in writing, and date it.
Large deductions for rental property . You might as well face the fact that large deductions raise eyebrows, everywhere they go. Rental property deductions are no exception and in fact they seem to be even more suspect than your run of the mill large deduction. If you own rental property and expect to have some significant deductions related to that property, keep excellent records and plan on including some detailed descriptions of the deductions on your tax return.