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Business // Thinking Smart
David S. Chang

Red Flags Could Get You Audited

This year taxpayers have until April 17 to file their 2011 tax returns because of Emancipation Day, a holiday observed in the District of Columbia that falls on April 16. The extra two days may help if you haven’t filed your taxes. Even if you have, it is important to take extra care in completing your returns.

With the U.S. government facing a trillion-dollar budget deficit, audits on tax returns have increased 11 percent from last year and have been more than double the agency’s pace just eight years before. The IRS audited nearly 1.6 million individual taxpayers in 2010, and tax experts expect it will continue to rise. Although the chances of facing an audit are still low, the penalties can be stiff if convicted of a tax crime. In 2010, the conviction rate of the 1,511 IRS cases recommended for prosecution was 90 percent, with an average sentence of 27 months.

Here are five red flags the IRS watches for:

1) Incomplete Returns: If you are missing information, the IRS will think that you have something to hide or have other items you didn’t disclose. Remember that a copy of your investment 1099s showing interest and dividend income are sent to the IRS. Your return must match them.

2) Large Deductions: The IRS has a computer program to compare your deductions with others in the same income bracket. If your deductions are significantly higher, then you may draw attention from the IRS. Take advantage of the deductions you have, but make sure that you can back them up. For charitable giving, you will need to show a receipt or canceled checks for cash contributions, and for anything above $250, you will have to show a statement from the charity. Non-cash contributions over $5,000 will require an expert appraisal. Make sure you follow all rules on deductions since some require certain thresholds to be met to take the deduction.

3) High Income: If your household income is more than $200,000, your chances of being audited triples. You should take extra care on your tax returns.

4) Home Offices: There are two basic requirements for your home to qualify as a deduction: regular and exclusive use, and it is the principal place of your business. Your office can’t double for other uses such as a kids’ playroom.

5) Losses: To write off personal or business losses, make sure they are legitimate and can be verified. With the tough economy, business losses are more common, but the IRS likes to double-check them.

Taking extra time on your return or hiring an accountant may be worth it to avoid penalties or back taxes. Tax preparation software also can help double-check your returns for accuracy and fix errors or omissions. Some feature an audit risk meter to show your chances of getting audited. Make sure to verify your math and the data you inputted on your return. If selected for an audit, the IRS isn’t necessarily accusing you of dishonesty, but is checking to see if your return is accurate. It is important to keep accurate records, receipts and other tax-related documents.

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