Wealthy Should Prepare for Audits by Keeping Organized Records

By Alan L. Olsen, CPA, MBA (tax)
Managing Partner
Greenstein, Rogoff, Olsen and Co., LLP

Expensive art collections, investment hobbies and offshore bank accounts may raise red flags when it comes to IRS audits. In 2011, the Internal Revenue Service audited 29.93% of taxpayers who reported more than $10 million of annual income [1]. This percentage increased by 18.38% from 2010.

Although there is no way to completely avoid being selected for an IRS audit, there are steps you can take to minimize the likelihood of an audit.

1. Be honest – Living by the simple rule of honesty will save a lot of stress. Report all income including; unreported interest, dividends or miscellaneous income. The IRS has record of all your 1099s, so be sure to report them. Omitting income will raise a red flag. Be sure to properly report all your expenses and deductions.

2. Be organized – Keeping organized records is important. Properly record any expenses that will be deducted. Business expenses such as travel, meals, mileage etc. can be deducted, as long as they have been recorded. Keep all receipts, they will help to prove an accurate deduction. Be sure to give exact numbers versus rounding. When it’s time to submit your return, double check and make sure there is no missing information or signatures.

3. Be prepared if you are self-employed – The IRS realizes that self-employment also increases the likelihood of unreported income. You must have proof of all income and business expenses if you are self-employed. Do not record personal expenses as business deductions.

4. Watch your deductions – Taking deductions that are unreasonable for your income bracket may raise a red flag to the IRS. Be sure you have proper records for proof of all of your deductions.

5. Avoid Fluctuation in Income – The IRS has a good idea of how much you make; if they notice a drastic change in your income this may raise another red flag. Be aware of reporting abnormally low income for your profession. On the flip side, be extra cautious if your income is over $100,000. IRS audits are 5 times more likely in this tax bracket.

6. Watch your Number of Charitable Contributions – Donating to charities is important, but be aware that a red flag may arise if you have made a lot of contributions. Hold on to all receipts, particularly if you are donating five times as much as the average person in your income bracket.

7. Use a Tax Professional – The best way to prevent or avoid an IRS audit is to use a CPA or accounting professional. These returns are often less likely to be selected for an IRS audit than a self-prepared return. A professional knows the laws and can help you to make sure that all proper deductions are taken and that all income is reported.

Taking these steps in preparing your return can help you to avoid possible red flags that could lead to an IRS audit.

[1] “IRS Audit Rate nears 30% for Those Making $10 Million and Up.” Bloomberg. Mar. 2012. Web. Sept. 2012. http://www.bloomberg.com/