Reducing Your IRS Audit Risk

By: Tom Wheelwright Click author's name for more of his/her articles

Are tax returns really the commodity that they are often perceived to be? Is a tax return prepared by the tax service in the mall of the same quality as that prepared by a major CPA firm?

What does it mean to have a "quality" tax return? In fact, can a tax return be prepared in such a way as to reduce income taxes or reduce audit risk?

As someone who has been involved in the tax return preparation process for almost 30 years, let me share some thoughts on this subject.

In all the firms and companies I've worked, the basic accuracy of tax return preparation was excellent. There was always a good review process and I don't believe there were major mistakes on very many returns produced by these firms. I find this also to be the case on returns that I see from clients who are new to ProVision. It's rare that I find a flagrant error in a return.

But does that mean that these firms all produce the same quality of tax return? The clear answer in my experience is a resounding "NO!" Let me explain.

Accuracy in a tax return simply means that the information provided by the client was reflected on the tax return. It does not mean that the tax return was prepared in the BEST way it could have been prepared. In fact, I RARELY see a tax return from a new client that was prepared the way we would prepare it at ProVision.

Tax Return Preparation Either Always Reduces or Increases Your Audit Risk Let me give you some examples.

Example #1: Where you claim your deductions matters Suppose you have some expenses that could either qualify as investment expenses or business expenses. Either classification would be "deductible" on the tax return. BUT, a business expense is MORE DEDUCTIBLE than an investment expense.

How is that possible? An investment expense is deducted on Schedule A and is classified as a "Miscellaneous Itemized Deduction." There are several limitations on a miscellaneous itemized deduction. First, you only get to deduct these type of expenses to the extent they exceed 2% of your income. So, if you have $300,000 of income and $7,000 of investment expenses, you only get to deduct $1,000. What's worse is that if you are in the Alternative Minimum Tax like millions of taxpayers, you don't get any benefit for your investment expenses.

How does this relate to audit risk? Miscellaneous itemized deductions tend to be more heavily scrutinized by the IRS, so they have a tendency to increase audit risk. In this case, how your tax return is prepared not only impacts how much you pay in tax, but also your audit risk.

Example #2: Tax return preparation matters even when you owe no tax Many taxpayers believe that their audit risk is low because they don't have any tax liability, so who and how their tax return is prepared doesn't matter. This is not necessarily true! Here's why:

Losses reported on Schedule C are commonly scrutinized because of the possibility of hobby losses (turning a personal activity into a "business" but not putting in the effort to turn a profit which makes the activity a non-deductible hobby activity in the eyes of the IRS).

Losses reported on Schedule E for rental real estate are commonly scrutinized to make sure the rental losses are indeed deductible. The rules in this area can be very complicated so the IRS is on high alert to catch errors.

Having no tax liability does not mean you are off the hook when it comes to audits!

Behind Every Secret Remember, behind every one of my secrets is knowledge - the type of knowledge that makes you aware of what creates massive tax savings so you begin to see your daily routine a little differently...like how to reduce your audit risk even while you are reducing your taxes!

Reduce your taxes now!

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About The Author: In all the firms and companies I've worked, the basic accuracy of tax return preparation was excellent. There was always a good review process and I don't believe there were major mistakes on very many returns produced by these firms. I find this also to be the case on returns that I see from clients who are new to ProVision. It's rare that I find a flagrant error in a return. WWW.ProVisionWealth.com