File a Squeaky-Clean 1040
Uncle Sam will be taking a closer look this year. So no red flags, okay?
(MONEY Magazine) – Some 12% of people admit they think it's acceptable to cheat on their taxes. No wonder IRS Commissioner Mark Everson has made it his top priority to go after those who shortchange the government. These few bad seeds can spell trouble for you, even if you play (mostly) on the right side of the rules. An iffy deduction here or a large write-off there could get your filing flagged for a time-consuming and potentially costly audit.
Though the number of people who get audited is still small—less than 1% of taxpayers—it's been rising steadily in recent years, thanks in part to the random-audit program that the IRS reinstated in 2002. Last year 1.3 million individual returns were audited, up 6% from 2005 and the highest it's been since 1998. And audits for people earning $100,000 or more are up 57% from 1998. If those stats don't scare you, this might: The number of so-called field audits, in which the IRS comes to your house for a full-blown inspection, increased nearly 23% in 2006.
The reason for the stepped-up efforts is simple. The IRS is trying to close what it calls the tax gap, or the amount Americans owe but don't pay. Estimated value: $345 billion a year. In times of growing budget deficit, that's a powerful incentive for the government to beef up enforcement.
Do you need to worry? If you're a middle-income wage earner with a straightforward return, probably not. But if you make more than $100,000, own a business or earn money from a side job, you're more likely to get that dreaded follow-up. Even folks who make charitable donations are drawing more scrutiny. "The IRS is looking at these situations as ones in which people are likely to fudge or push the limits," says Donna LeValley, contributing editor to J.K. Lasser's Your Income Tax 2007. No matter what your situation, however, remembering these three points can help you escape IRS notice.
› GO ELECTRONIC Math errors and missing signatures are signs of a sloppy return. "These are innocent mistakes, but they increase the potential for greater scrutiny," says Mark Luscombe, principal tax analyst at CCH. IRS computers spit out incomplete or erred returns for a closer look by a human, who's apt to reread it with a skeptical eye. Tax prep software and e-filing can help you catch such mistakes before it's too late.
› STAY IN LINE WITH PEERS The IRS uses statistical analysis to determine what's typical for a return based on factors such as the tax bracket, zip code and profession. The formulas are closely guarded, but safe to say, if you have a deduction putting you out of the range they predict (say, you earn $75,000 and donate $15,000 to charity), your return will raise red flags. To see if the deduction you're planning to take is outsize, go to irs.gov/taxstats, click on SOI (Statistics of Income) Bulletins, pick Fall 2006, scroll to individual tax returns and open Table 3. Divide the amount of the deduction by the number of returns in your bracket to get the average. This isn't to say you should avoid taking a qualified break just because it's above average; but if you do, you may want to attach a brief form of proof, says Luscombe.
› DON'T LEAVE OUT ANY INCOME The IRS gets copies of your W-2s and 1099s and then cross-checks what you file against what your employer and financial institutions report. If there's any discrepancy, you'll hear about it. The IRS contacts nearly 2 million taxpayers each year because their returns are missing income. A letter audit isn't necessarily cause for concern, though it's a hassle and could lead to more review. Better to include everything, or be prepared for the tax man to come a-knockin'.
MANY UNHAPPY RETURNS
1 in 100 taxpayers are audited
1 in 60 taxpayers earning at least $100,000 are audited
1 in 16 taxpayers earning at least $1 million are audited
NOTE: For fiscal year 2006, which runs from October 2005 through September 2006.
...Flirting with disaster 49% of respondents in a recent survey conducted by Quicken said they had no emergency fund stashed away...