1. Filing the old-fashioned way. You already know how we feel about the ease of filing with Turbo Tax (love it), but did you know that filing electronically can also reduce your chances of being audited? That’s because of, well, human error. Simple miscalculations like putting the wrong number in the wrong box or skipping a line happen far more often when you’re filing with pen and paper instead of plugging and chugging online. In fact, nearly 10 million taxpayers make math errors on tax returns every year, many of which result in filing delays or audits. So save yourself time, money, and a headache and e-file.
2. Filing as a freelancer. If you rake in a regular salary, W-2 and all, you’ll likely have a fairly straightforward tax filing process. But for less traditional workers, like freelancers and independent contractors, the process of keeping track of where your income came from can be daunting. It gets even more confusing if a client or vendor sends a 1099 or similar tax form after you’ve already filed, leaving you with the burden of filing an amended and corrected return. We know it’s no fun, but unless you want to hear from the IRS, it’s up to you to keep diligent records and report your income honestly. Don’t be one of the 4 million taxpayers annually who receive notices saying that they under-reported income; this can (and often does) result in an increase in tax liability and additional tax and penalties.
3. Claiming a credit you don’t deserve. Nearly a third of all audits come from taxpayers who try to claim deductions that they don’t deserve. At its core, the Earned Income Tax Credit (EITC) is designed to help lower to moderate income taxpayers reduce tax burdens, and possibly even get money back if the EITC exceeds the amount of taxes owed. Why? Because many people legitimately need it. But attempting to reduce your income by taking a slew of deductions, or not claiming income that is subject to tax in order to qualify for credit will cost you far more in the long run. Better to be honest about what you’re making and pay back into the system accordingly than to get into a scrap with the IRS.
4. Mishandling rental income. We talk about it all the time: now is the time to be renting. And we don’t mean just renting an apartment to live in; we mean renting out property you own as well. But you may not know that rental property owners are required to file a Schedule E, and it’s important that you understand the nuances behind it. Here’s why: real estate rentals tend to reflect losses due to depreciation write-offs (that is, deductions for damages or other losses in the property’s value due to heavy usage). Most of the time, those losses are limited on your tax return, unless you qualify as a real estate professional (which we’re guessing you don’t). You might be tempted to take these losses on your individual tax return, but bad news: you’ll probably get audited. To limit audit risk, you should either look into forming an LLC for your rental properties or really familiarize yourself with the rules for being considered a real estate professional. Those rules include the following: you must devote at least 500 hours toward the rental property in order to take deductions on the property, or invest 750 hours to managing the rental.
5. Thinking small. Every small business wants to be a big business…until it comes to taxes. But don’t think you’re too small to be audited. Small businesses with gross incomes of more than $100,000 are five times more likely to be audited than those who do not file a Schedule C. To lower your audit risk, make sure your company is incorporated, and be careful to separate personal and business finances properly. Other audit red flags that small businesses should look out for are income that varies greatly from year to year and having employees, including freelance workers. Also at a greater risk are businesses with a high volume of cash-based transactions. When using a Schedule C to report all income, deduct only the expenses entitled on the Schedule C, which includes costs related to advertising, insurance, legal services, vehicle expenses, employee wages and taxes, home office expenses, and depreciation. And remember: always have backup documentation for business expenses (i.e., receipts and invoices) at the ready in case you need to prove they’re legit!