Looking Out for Those Audit ‘Triggers’ : Taxes: Certain deductions--casualty losses, self-employment and home office are some--can often lead to IRS scrutiny.
The Internal Revenue Service has vastly expanded its computer matching program, which may cause thousands of additional taxpayers to trigger so-called “computer audits” on their 1993 returns.
The nation’s tax police have also boosted scrutiny of those who claim certain types of income and deductions. These so-called “audit triggers” boil down to a handful of expenses, deductions and credits that the IRS believes are frequently exaggerated or fabricated. This year, the audit triggers include self-employment income and claims for the earned income tax credit.
Accountants stress that taxpayers should never forego a legitimate deduction for fear it will cause them to be audited. But, they should be ready to provide clear substantiation of these highly scrutinized items.
Indeed, some people may want to attach extra documentation to their returns--information that would be required only in an audit--as a preemptive effort, says Philip J. Holthouse, a partner at Holthouse, Carlin & Van Trigt in West Los Angeles. An IRS agent may look at the additional paperwork and decide it’s enough to substantiate the deduction.
What items are likely to single out a return for a closer look by the IRS?
* Self-employment income. There isn’t much you can do about it, but if you work for yourself, you are far more likely to be audited than somebody who works for someone else. That’s partly because the IRS believes that many people who call themselves “independent contractors” or “self-employed” are mislabeled employees who aren’t due deductions for business expenses.
You need receipts of deductible business expenses, contemporary records of entertainment and travel costs, records of taxes paid, income earned and where your income came from. You may also want to keep work contracts and records of people you’ve contacted in an effort to get work.
* Casualty loss deductions. These normally rare deductions are likely to be fairly commonplace on 1993 returns, thanks to the devastating floods in the Midwest and the fires in Southern California. More recent losses, such as January quake damage can be deducted on 1994 or 1993 returns. If you have a casualty loss, be sure to keep good records, including a copy of your insurance adjuster’s report on the value of the items you lost. Keep appraisers’ reports detailing any disaster-related decline in the market value of your home, if you’re claiming that decline as a casualty loss. And compile documentation that shows the cost of what you lost. (For tax purposes, you can deduct the lesser of the decrease in market value or the cost of the items you lost.)
This is a prime example of where you could benefit from including extra documentation, Holthouse notes. If you have a casualty loss, consider attaching a copy of the appraisal report and the statement of what is uninsured. An IRS agent may look at those documents and decide there’s no need to call you in for further information.
* Home office deductions. If you write off a portion of your mortgage and utility costs because you work from home, you are very likely to be audited.
Indeed, accountants say your chance of being audited when claiming a home office deduction is so high--and home office deductions are usually so small--that most people should think twice before making the claim. You could spend more defending yourself than you’d save by taking the deduction.
If you do decide to take the deduction, make sure you keep records of meetings held at your home, hours worked and the types of activities done there. For the deduction to be acceptable to the IRS, your “most important” jobs must be done in the home office; the room you use as an office cannot be used for any other purpose--in other words, it can’t double as your den--and you generally must meet clients there.
* Earned income credit. This year, for the first time, the IRS is running all returns that claim this lucrative credit for low-income families through a computerized program that will check the names, Social Security numbers and ages listed on the EIC form to information on file with other federal offices.
That’s likely to kick millions of returns out of the system even before they’re completely processed, IRS officials say.
* Personal bad debt deductions. If you loaned money to a friend or family member who cannot repay the money, you can claim a bad debt deduction.
But beware. You’ll need a signed note showing that this was a loan--not a gift--and you will need to show that you made an effort to collect the money. Otherwise the IRS will disallow the deduction.
* Barter income. Let’s say that an orthodontist, who wants to have his kitchen remodeled, hooks up with a contractor, who has a child in need of braces.
The orthodontist and contractor strike a deal in which the orthodontist provides the braces. The contractor does the kitchen in exchange.
No money changes hands, but they’ve both got barter income. If one of them reports the barter income on a tax return and the other doesn’t, both could be audited.
YOUR TAXES
A Special Report, D6-D11
