The fear of a tax audit can make people do funny things.
I’ve seen people give up thousands in legal tax savings in an effort to hopefully avoid the possibility of an audit, and many times at the advice of their own tax advisor.
I regularly have clients tell me their prior tax advisor told them not to take a particular deduction because the deduction wasn’t worth the audit risk.
Then there’s the other side who take deductions they are unsure of and hope they don’t get audited.
When it comes to audit risk, there are two factors to consider:
First, there’s the risk of being audited. There are elements of this risk that can be controlled through proper tax planning and tax return preparation. There are also elements that cannot be controlled.
Second, if you are audited, there’s the risk that adjustments will be made resulting in increased taxes, plus penalties and interest. Proper tax planning and tax return preparation can provide you with tremendous control over this factor.
When done right, identifying legal tax saving opportunities actually helps reduce your audit risk.
#1 Following the Tax Rules
The majority of the tax law is intended to reduce your taxes, not increase it. If you follow the rules, you’ll enjoy legal tax deductions and be well-prepared for an audit.
The challenge most people have with this is they don’t know the rules and have no interest in reading the tax law to learn them.
This is why you need a great tax advisor on your team.
Leverage your tax advisor’s knowledge to open a whole new world to what is legally deductible. Understanding exactly what you need to do to legally claim your deductions means that even if you are audited, you have followed the rules and minimized the likelihood of having any audit adjustments.
For example, if my client has a home office, we go through the home office rules. By making sure the rules are followed, I’m not only making sure my client qualifies for the deduction, but that they know how to document the deduction.
#2 Keeping Proper Documentation
The better your documentation, the greater your tax savings.
And, the better your documentation, the more prepared you are for an audit.
Most people hate this step because it’s tedious and boring. But, which would you prefer: a little work now to get your documentation in place or having to do it later while an auditor is waiting for it (when it’s much more difficult to remember and find it)?
When you are able to quickly provide an auditor with the documentation they request, the audit usually wraps up quickly.
Reduce Your Taxes, Reduce Your Audit Risk
When I work with clients to create and implement a tax strategy, the result is legally reducing their taxes, but the process includes several steps that actually help them reduce their audit risk at the same time.