By Milton Zall
March 2001 - With April fast approaching, time is getting short for determining how much money you're obliged to share with the IRS. Although you must file an income tax return (by April 16, or later if an extension is requested), do not overlook perfectly legitimate deductions that can reduce your tax liability. It's OK to reduce your tax liability if everything you deduct is lawful.
An important rule to keep in mind when deciding what to include on your 2000 tax return is that all deductions must be verifiable. If the IRS audits your return and questions a deduction, the burden of proof is on you! The IRS can disallow any deduction that cannot be verified through acceptable documentation. That doesn't mean the IRS will demand documentation for every deduction; auditors usually limit document requests to deductions that appear questionable. However, you never know who is going to audit your return, and some auditors can get carried away. The message: Don't claim tax deductions you cannot readily document.
Avoiding an audit is another important consideration. While only 1 percent of all individual returns are audited, you don't want to be among such select company. Various factors determine whether a return is audited. One of them is the number of deductions claimed. IRS computers rate taxpayers according to a closely guarded formula, giving each a "DIF" score (Discriminant Function system). A high score increases the likelihood of an audit. Tax experts believe there is a direct correlation between the percentage of itemized deductions and adjusted gross income (AGI). Some say the IRS may seriously consider your return for an audit if your deductions equal or exceed 35 percent of your AGI. In addition, the IRS will compare your deductions to the average taken during the most recent year for which data are available.
The IRS recognizes that individual situations differ. For example, the owner of a new home will have higher interest charges than someone with comparable income who has lived in the same house for 20 years or someone who rents. Similarly, individuals residing in high-tax states are expected to claim higher local taxes, just as young families are expected to have larger medical expenses. If your income is unusually low or your deductions are unusually high for a given year, you should attach an explanation with your tax return. After a computer selects a return for possible audit, an IRS employee examines the return to see if the computer made a proper selection. Your attached documents may make all the difference.
Milton Zall is a freelance writer based in Silver Spring, Maryland, who specializes in tax, investment, and human-resource issues.
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