Frequently Asked Questions
How can you avoid an audit?
Being honest and accurate is a good start. As many harried taxpayers know, however, that's sometimes not enough. Anything out of the ordinary can trigger an audit. The IRS looks for such things as a large charitable deduction from a moderate wage earner or neurosurgeon who reports a teacher's salary. The IRS also targets certain taxpayers, including the self-employed and professions with cash income. High wage-earners are always at higher risk for an audit.
To reduce your exposure, be sure to report all your income. The IRS matches income on your return with the W-2s and 1099s that businesses file. Be sure to take all the deductions to which you are legally entitled. If anything looks unusual, consider attaching receipts to head off an audit. Even then, you can't be sure the IRS won't send you a notice. Every year, the agency selects a small percentage of taxpayers to audit at random.
How can you save on your taxes?
Start by planning way ahead of tax day. You will then have plenty of time to figure out how to reduce the taxes you pay next year and down the road. Whatever you do, be sure to keep your overall investment strategy in mind.
Make sure you take all the deductions to which you are legally entitled. You may qualify for a home-office deduction or a write-off on travel for charity work. Contribute the maximum to tax-deferred retirement plans, including 401(k)s, IRAs, and SEPs. Consider buying investments that are free of federal or state tax liability, such as municipal bonds and U.S. Treasury bonds. If you are self-employed, you may want to push income into next year and bring deductions into this year.
There are many ways to lower your taxes. You may need to consult a tax advisor to find the best solutions for you.
Will you save big on taxes if you buy a home?
You won't get rich, but you can save a sizeable sum if you claim the mortgage interest deduction on your taxes. The higher your tax bracket, the more attractive the deduction. For example, a homeowner taxed at a 38 percent rate would save an average of about $2,500 annually over 30 years with a $100,000 mortgage at 7 percent. The biggest savings come in the early years and decrease as the loan's balance declines.
What records should you keep to make tax filling easier?
Your previous tax returns are a handy reference. You have already filled them out with facts you use every year. They also contain important information that you may need down the road, such as the tax basis of your home.
Other documents include records of income, expenses, and items you report on your tax return, such as taxes and bank accounts. Be sure also to keep records of anything of value you may sell later, including collectibles, stocks and bonds, and jewelry.
You should keep these records where you know you can find them. A filing cabinet will do for most papers, including tax returns and most receipts for deductible items. Receipts for high cost items and anything you may have difficulty replacing in event of a disaster belong in a fireproof safe or a safe deposit box. Keep all supporting records for at least three years in case of an audit.