Even though tax season is well behind us, there are steps you can (and should) take today to make the possibility of a future IRS audit a remote possibility. Keep in mind that after December 31st passes, you may not be able to alter your tax strategy for the prior year. That’s why it’s so important to be aware of audit risk before it becomes a problem.
What are the risks?
Your overall chances of being audited by the IRS are only 1.11% according to the IRS. But if your income is between $300,000 to $1,000,000 your chances are almost 3 times greater. And if you earn more than $1,000,000 per year your chances are almost 12 times greater. It makes sense for the IRS to spend more time auditing wealthier people. That’s where the money is.
But high-income earners aren’t the only individuals that fall under the IRS’ watchful eye as you’ll see. Here’s what you can do to cut your risks to the bone:
1. Investment Expense
If you are a stock trader you have to report your gains and losses. According to the Investor’s Business Daily, you’ll get more deductions if you report them on Form 8829. If you go this route, the deductions will flow to your Schedule C rather than listing them out on separately on Schedule A which is widely used for miscellaneous itemized expenses.
The only caveat is that you can only use Schedule C for trading gains and losses if you are a trader. Also, only expenses greater than 2% of your adjusted gross income can be used for tax deductions.
What you need to do now.
Keep careful records. You might qualify as a trader for some investments and as an investor for other securities. Ask your tax preparer about this if you want to avoid getting a nasty letter from the IRS. And don’t start thinking about this next year. The last thing you want is to have to scramble around searching for data. Get set up for this now friend.
2. Cost Basis
Brokers are required to report cost basis for mutual funds, stocks and bonds. All you have to do at this point is to call your broker and make sure that they are compliant. If they aren’t they are breaking the law. If that’s the case, it’s probably a good time to find a new custodian.
This may not seem like a big deal now but it will be in 10 years from now if you need your cost basis and can’t find it. Selling old securities is one of the IRS audit flags the tax police love to use. Don’t let them trip you up.
3. Foreign Accounts
In the good old days you only had to report bank accounts you had in foreign countries. Now you must report assets you hold outside of the United States as well. And you have to report all those assets on form 8938. Get familiar with the forms now and make sure you have all the information necessary to complete those forms.
4. Self Employed
If you are an independent contractor or sole proprietor you use Schedule C to report income and expenses. But just by filing Schedule C your odds of an IRS audit jump to 4.3% (assuming your income was between $100,000 to $200,000).
If you run your own small business and are sure you want to do so as an independent contractor make sure you keep meticulous records – and be ready for an audit. If you are not fixed on the idea of being an independent contractor, consider some other business formation.
Have you ever been audited? What was it like? What was the main reason you were audited? What do you differently now?
Ronald Dodge says
I have been audited by the IRS 2 separate occasions
The first time, I was considered as an under-reporter evidently as I went from 1987 (when I was only 17 at the end of the tax year) to 1996 without filing a tax return. That was because I claimed “EXEMPT” on the W-4 form, I met the requirement to not have to file, and I expected no refund from the IRS. The only other income I had, though only until July 1994, was Child SSDI. Even with that and what little income I had, the provisional income didn’t reach the $25,000 threshold limit (Which is still the limit as either a single or HOH filing status), thus none of my Child SSDI was taxable income.
Luckily, I kept all of my W-2s (Yes, people say you only need to keep the last 7 years). That was because given I didn’t file for all of those years, that 3-year and 6-year statutory time limit didn’t get started. I sent them a copy of each W-2 along with a letter of explanation to the IRS for all of those years (1987 to 1996), which they audited all of them. They then ended their audit after that.
What have I changed from that audit?
Always file a tax return from either the time you start to have some tax form or the year you reach adult age (18), whichever comes first. Even for those in their elder years strictly on SSA benefits with no other income coming in, still file that tax return. One such reason why it is important to file, even in your younger years when you aren’t making enough to be required to file with the IRS, you don’t want the IRS auditing you 30 to 40 years later to attempt to get all of that money out of you just because you didn’t file in those early years to start that time clock with the IRS. It’s also important for in retirement years, so as the IRS can’t take advantage of you when your mind is no longer all there but yet, you are still considered to be mentally competent.
The second time, the IRS audited me, it was triggered by the fact I went back to college in September, I already had so many credit hours earned from before, and I also paid back some of the unemployment benefits to the state of KY, which the state of KY never reported to the IRS.
I was able to get documentation from the unemployment office to show that I did in fact pay back that money, and that I did truly spend more than $4,000 on my education that year, given the WIA program of the unemployment office in KY and the University of Cincinnati would not work with each other, thus ultimately, I had received no help from the so called WIA program, even though the WIA program is intended to pay for training and education expected up to a certain amount (about $7,800) after taking into account of scholarships and grants.
What have I done differently?
Nothing really other than just have to pay closer attention and follow through with the rules. As to how the unemployment office worked, I hated it and I hope I don’t ever have to deal with it again as it was a very bad experience.
As to my education, I ultimately had to earn 336.5 quarter credit hours all within the Accounting major just to get my BBA. That also doesn’t include the 40 quarter credit hours’ worth that was repeated from high school (19 of them alone being in Accounting including 3 of the 4 quarter credit hours of the college senior level “Accounting Information System” course, which my high school 2 years of accounting courses at the vocational high school specialized in. The only thing the high school accounting course work didn’t take into account was the threats, but it had everything else in it that was in the college senior level AIS class). To get the BBA, it should only take 180.
So now, I have earned a total of 387.5 quarter credit hours (All in Accounting), having earned the master’s degree, not counting the other 40 hours worth that was repeated from high school, which would actually take it up to 427.5 quarter credit hours. The bad news, as all the colleges would disagree with me, 195 of those quarter credit hours were repeat hours. Only 5 of them was due to a poor grade in one course. All the rest of the 190 hours was due to the money game of the higher education system. This game was so bad, I wiped out all 6 years of the Pell Grant to get my BBA in Accounting. Had I not pushed those 90.5 quarter credit hours within the 15 month window, I would have had to come up with my own money to make up for that last semester. Instead, I took 18 quarter credit hours in the fall of 2011, 20 quarter credit hours in winter of 2012, 19 quarter credit hours in the spring 2012, 11 quarter credit hours in the Summer 2012, and 15 semester credit hours in the Fall 2012, passing them all with a GPA of 3.88 to graduate with the BBA in Accounting, as the Pell Grant just barely made it through.
Total cost for the BBA before scholarships and grants: $200,000
Total cost for the BBA after scholarships and grants: $100,000
Total cost for the MS before scholarships and grants: $26,000
Total cost for the MS after scholarships and grants: $20,000
If you look at the cost figures, it makes the cost of the MS very minor compared to the cost for the BBA, even after taking into account the fact the BBA is only suppose to be for 4 years while the MS is only 1 year.
What am I doing differently after this situation?
First, I have no trust in my kids going to so called community colleges, even the ones that claim they have guarantees with the local universities that those courses would transfer to the university for the majors the students are going for. All 93 quarter credit hours I earned at Cincinnati Metropolitan College in just 15 months, including having gone through 2 major phases of testing to pinpoint where the seizures started from, and the actual laser brain operation, and in the last quarter, taking the last 16 quarter credit hours and doing 20 hours a week co-op for the entire quarter, and graduated with a GPA of 3.87 for my Associates in Accounting. In the Winter 1991, I took 24 quarter credit hours, which included the fact, 2.5 of those weeks, I was in the hospital for the first phase of testing, and I nearly aced everything. Spring 1991, I took 28 quarter credit hours, and aced all of my courses. They tried to force me to take courses in the summer of 1991, but I simply told them, I couldn’t given the 2nd phase of testing and potentially the actual operation provided I qualified for the operation, which evidently, I did as I had it done and more or less been seizure free since other than for the 2 semi-seizures I had 2 days after the operation. That also meant up to 4 week recovery. They told me, I had to have the FMLA paper work filled out and returned to them to not have to take courses during the summer 1991, and I did so. Fall 1991, I took 25 quarter credit hours and aced all those courses. Winter 1992, I took the last 16 hours, did the 20 hours a week co-op (the bus system was my only means of transportation at the time), and aced everything.
The sad things, the school defrauded me of $11,000 (1992 dollar value) I was owed as a refund, the school went belly up, which I saw none of that money, even with filling out that bankruptcy paperwork, and the state board of education in Ohio has no record of me going to the college. This is where my distrust come from, and this also means I have to check accreditations of the colleges that my kids want to get into.
Second, while when I was in high school, they had no such thing as AP courses or dual enrollment courses, I am wanting my students to take part in that. However, I have one major caveat to that. I must have in writing, those courses will not only transfer to the said university/ies, but those courses must also apply to the said major my kids want to get into. That’s because even though a lot of my credit hours did transfer to the University of Cincinnati, they didn’t apply specifically to my major, even though all of my hours earned has been while in the Accounting major. The reason why I also mentioned universities, it’s because in the state of Ohio, there is this Tag program, which all of those said courses are suppose to be transferable to every single public college within the state. At one of those meetings dealing with information for the Tag Program, I was told, I am the poster child as to why the Tag Program was created.
Within a 28.4 month period this time around during my unemployment time period, I earned 141.5 quarter credit hours earning my BBA and MS in Accounting, and I passed all 4 CPA exams. Most people would take about 4 years to do all of this. I did go through a 7 week period of training dealing with Java and other things, and I was paid good money for that. This week, I will also be submitting my application for my original CPA requirement as I currently am only lacking one reference, which I will get that Tuesday evening from one of my clients and bowling teammate. I have already met all other requirements other than submitting the application with the original documents including my experience record form, experience verification form, ethics requirement.