Don't Get Caught Off-guard by an IRS Audit

Physician's Money Digest, January 2006, Volume 13, Issue 1

Tax

Savings Report

The slogan "Uncle Sam Wants You"is taking onnew meaning for an increasing number of taxpayers.According to a recent article in the (www.ntu.org), taxpayer audits rose14% in the 2003 fiscal year and by 24% for individualsearning more than $100,000. A sluggish economyand a major federal budget deficit are the main reasonsfor the step-up in audits. But regardless of the reason,it's more important than ever that your tax return doesnot contain any errors or red flags.

Finding Some Answers

How can you minimize the chance of an audit? Ifyou're not currently using a professional tax preparer,you might want to consider one. According to the IRS,taxpayers who prepare their own returns are 3 timesas likely to make errors as paid tax preparers. Anotherimportant point is to make certain that you have theproper documentation for any deductions you take. Inparticular, deductions for home offices, travel, entertainment,and charitable contributions are some of themost commonly abused. As such, they receive closerscrutiny by the IRS. According to the article, the IRScompares one taxpayer's deductions to the average ofothers in the same income bracket as a means of narrowingits list of audit targets. In this case, the higheryour tax return scores, the greater the chance you willbe audited by the government.

Audits come in all shapes and sizes. If you're lucky,you might only receive a letter asking you to providedocumentation for deductions you took. At the otherend of the spectrum, you could be summoned to anIRS field office to review the return. But, as the articlenotes, an audit is not necessarily cause for alarm.Where you run into trouble is if you've been deductingthings that you can't prove.

When deducting for a home office, it's importantto remember that the space in your home thatyou're claiming must be used exclusively for businesspurposes. IRS Publication 587, "Business Useof Your Home,"can help you determine if youqualify for this deduction. In general, a home officemust be separate from your living area if you planon deducting a portion of your rent or mortgage,insurance, and telephone and utility bills.Unfortunately, simply having a desk with a computerin your den or living room doesn't qualify. TheNational Taxpayers Union points out that anothersensitive area is travel and entertainment when itcomes to deductions. Here, tax preparers suggestthat you do not deduct travel and entertainmentexpenses if you do not have the proper documentation.The few dollars you might save, they pointout, is not worth the risk of being audited.

Any Happy Returns?

If you're among the taxpayers receiving a return, theimportant question is: What are you going to do withthe refund? The temptation is to spend it on somethingfun. Instead, you should focus on the basics: payingdown debt, preparing for emergencies, and mostimportant, adding to your retirement fund.

If, however, you've diligently funded your retirementaccounts, the next best use for the refund is payingoff debt. Pay off the debts on credit cards with thehighest interest rate first, and then work down fromthere. And because interest on home equity loans isdeductible, put those at the end of your list.

Lastly, consider starting that emergency fund thatyou've been putting off. With the present state ofunemployment and the economy, financial plannerssuggest you set aside enough to cover at least 6 monthsworth of expenses. Doing so will give you peace ofmind that you're prepared for whatever might bearound the corner.