Audit proofing protects your deductions and credits
A tax deduction reduces the income you are taxed on. It makes you pay a lesser amount of tax than you would have without it. On the other hand, a tax credit reduces your actual tax bill. The impact of a tax credit is bigger than that of a deduction on your payable taxes. Nevertheless, these two result in the IRS losing some money that they refund you. They would not want to take this lying down. They will try to avoid it from happening, especially given how some taxpayers commit fraud to score extreme deductions and credits. Therefore, this gives you even a bigger reason to audit proof.
What happens if you do not audit proof?
This is the biggest question right now, which, the answer is simple; you will be audited and lose! Therefore, the right thing to do is to audit proof. However, let us get into the intricate details about audit proofing. I say this because there is a method you must follow when audit proofing, for example, bookkeeping. And here is the link between bookkeeping and audit proofing – your transactions in your bookkeeping need to be substantiated using paperwork.
Without audit proofing, your expenses are not safe
Major expenses in your tax return may attract IRS scrutiny. These include unusual expenses that you undertake for a specific purpose. For example, you could be in the process of renovating your office and buy paint and new furniture. These expenses may not be ordinary in your industry. But they were necessary to complete the renovation process. However, the burden of proof lies on you. You need to show the IRS that it was, indeed, necessary to buy paint and new furniture for your office.
The process of proving that the expenses were necessary is called audit proofing. It includes processes such as creating and populating logs for such specific tasks (renovating). It also includes receipts capture and storage. Failure to do so means that you are not audit proofed. And, if the IRS decides to audit such expenses, you will be asked to pay more tax with interest.
No deductions and credits are safe without audit proofing
That’s right, audit proofing protects your deductions and tax credits. The whole idea of audit proofing is so that the IRS will not deny the deductions that you claim. Remember, when you claim itemized deductions, they must be legitimate. This means that you must have really incurred an expense that makes you qualify for the deduction. For example, if you are to deduct medical expenses, you must have really have visited the doctor during the tax year. However, the IRS was not there when all these transactions happened. What will make them believe it is the proof you are prepared to give. It is the detailed records that you will provide.
Without the proof (receipts and other documents), your deductions are simply not safe. The same applies to tax credits such as the Earned Income Tax Credit and the Child and Dependent Care Credit. You need to prove that the children are yours, or they live under your roof. As for the Earned Income Tax Credit, you need to prove that you meet the qualifying criteria. If you can’t do that, your tax credits are not safe. That may result in a heartbreak at a later date. Why? Imagine claiming a non-refundable tax credit that reduces your tax bill to zero. But after some IRS scrutiny, they find that you did not qualify and reinstate the tax bill with interest? That will cut deep.
The bottom line
A dangerous misconception I have observed is that many taxpayers believe that they are safe and do not need to audit proof. They argue that it is only a few who get actually audited by the IRS. Well, you might run for a couple of years, but you will certainly not hide forever. It only takes one audit to change your life forever (make you broke). Do not be the one to cause permanent financial damage to your own life. Audit proof now.
Join my upcoming audit proof masterclass to be presented on July 29, 2021. Follow this link to get yourself a spot and ensure that you keep yourself safe forever. Audits are real and can be devastating, you need this!
People have also asked the following
1. What Is a Tax Deduction?
A tax deduction is a deduction (amount) that lowers a person, or a business’ taxable income. This lowers the overall tax liability. Deductions are grouped in two: The standard deduction and itemized deductions. The standard deduction is an amount pre-set by the government, whereas itemized deductions are more than one, and depend on the taxpayer.
2. What is the difference between tax deductions and tax credits?
Tax deductions affect the taxable income – they reduce it so that the taxpayer is taxed on a reduced amount. Whereas tax credits affect the tax owed or actual tax amount. They reduce it dollar for dollar. For example, if the IRS calculates that you owe $500 tax, a $100 tax credit results in you paying $400.
3. How Much Can You Deduct?
It depends on what you choose (standard or itemized deductions) as well as your taxpayer profile. For example, in 2020, a single taxpayer could deduct a standard deduction of $12,400. But if they chose to itemize their deductions, the amount could be anything.
4. How Credits and Deductions Work?
Credits directly reduce the tax amount you owe, dollar for dollar. Whereas deductions reduce the amount of your income that is taxed.
5. How to Calculate the Home Office Deduction
A home office deduction is calculated using two methods. These are the simplified option and the regular method. The choice you make depends on your personal preferences or the nature of the home office.