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Money Management

Money Management is a weekly column on personal finance prepared and distributed by certified public accountants.

FOR IMMEDIATE RELEASE: March 24, 2003

DON’T BE AN IRS AUDIT TARGET: AVOID WAVING RED FLAGS

When it comes to income tax deductions, you should certainly claim those you deserve. But also keep in mind that too many deductions, as well as other problems like math errors, can attract the attention of IRS auditors. To be prepared to address IRS inquiries, the New York State Society of CPAs provides a look at some ‘red flags’ that may cause the IRS to take a second look at your tax return.

A HIGH DIF SCORE

Most returns are selected for audits by an IRS computer-generated program that compares the deductions you are claiming on your return to other returns in your income bracket. To arrive at a DIF (discriminate function) score, the formula also considers where you live, the size of your family, and how your income is earned. For example, if you were to report income of $60,000, live in an exclusive neighborhood with your family of six, and claim $15,000 in mortgage interest, the IRS may want to chat with you.

FILING SCHEDULE C (PROFIT OR LOSS FROM BUSINESS)

How you generate your income may increase the likelihood of your return being selected for an audit. For example, your chances rise sharply if you file Schedule C. That’s because the IRS is well aware that self-employed workers have more opportunities to hide income and to transform personal expenses into business deductions. Workers who receive much of their income in cash, such as those in the gaming, food service, and entertainment industries, also can expect a higher level of scrutiny.

FORM W-2 AND FORM 1099 DISCREPANCIES

In recent years, the IRS has enhanced its document-matching program, which compares the information sent to the IRS by taxpayers’ employers, clients, and financial services providers to what’s reported on the return. To avoid attracting the attention of IRS auditors, make sure the numbers you report accurately match the information the IRS receives. Check your W-2 wage statements and Form 1099s as soon as you receive them and, if the information is incorrect, ask the issuer to send revised forms to both you and the IRS.

INCORRECT SOCIAL SECURITY NUMBERS

Be sure you record the correct Social Security numbers for yourself, your spouse, and your dependents. The government uses Social Security numbers to check whether a child is claimed as a dependent by more than one person. It’s also important that you review the Social Security numbers on your W-2 forms. According to the IRS, an incorrect number on a Form W-2 results in the return being categorized as “not processible.” In such cases, a refund is delayed until the IRS obtains the correct Social Security number.

MATH ERRORS

Verifying the accuracy of the math on your return is one of the easiest ways to escape a second look by the IRS.

CHARITABLE DEDUCTIONS DISPROPORTIONATE TO INCOME

Be careful about claiming deductions for donations not in line with your income. If you report income of $50,000 and donate $10,000, you may be doing a noble thing, but the IRS is likely to want to know more. In such a case, you may want to include support documentation with your tax return.

Keep in mind that if you donate more than $500 in non-cash property, you need to fill out Form 8283, Noncash Charitable Contributions, and attach it to your return. One more caution: In recent years, after realizing that many taxpayers inflated the values of cars donated to charities, the IRS is looking more closely at car donation programs. If you give your car to charity, you are allowed to deduct its fair market value, which must take into account the car’s condition and mileage. If the car’s value exceeds $5,000, you are required to obtain a written appraisal from a qualified appraiser that supports your information.

TAKING A HOME OFFICE DEDUCTION

Although the rules governing who can qualify for the home office deduction were relaxed in 1999, they are still complex and apply to only a limited number of employees. While you certainly should claim the home-based office deduction if you operate your business from your home and meet all the requirements, be aware that this might invite IRS scrutiny. Read carefully IRS Publication 587, Business Use of Your Home, before deducting expenses associated with a home office.

DON’T HESITATE TO TAKE DEDUCTIONS YOU CAN SUBSTANTIATE

CPAs emphasize that these precautions should not suggest that taxpayers avoid claiming legitimate deductions. On the contrary, you should take every deduction you are legally entitled to take, as long as you retain supporting documentation.

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PUBLIC SERVICE ANNOUNCEMENT
CPAS FLAG ITEMS THAT MAY RESULT IN IRS AUDIT

Approximate Length: 30 seconds

Although tax returns subject to IRS audits are randomly selected, by claiming certain deductions you may draw the IRS’s attention. The New York State Society of CPAs points out that most returns are selected for an audit by an IRS-computer generated program that compares the deductions you claim on your return to other returns in your income bracket. For example, if you have a modest income but claim high deductions for charitable contributions, you risk being audited. Claiming the home office deduction or providing erroneous information, such as a wrong Social Security number or wage information, also can trigger an IRS inquiry. So, too, can math errors, so check your tax return carefully before submitting it.


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