If you have an adventurous, thrill-seeking personality, your life may never be complete until you’ve solicited an income tax audit from the Internal Revenue Service. There is good news and bad news for you. The good news is that audits have been more frequent in past years, so the chance of being audited has increased. The bad news is that budget cutbacks might force the IRS to reduce audits for the 2010 tax year and beyond, so you might not have the opportunity to provoke an audit unless you try hard. You may not want to leave this up to chance, so here are a few concepts that when applied will tip the scales in your favor.

I would prefer to avoid an audit, but I realize that different taxpayers have different priorities. My strategy is to take the opposite approach of what is recommended throughout this article. Thrill seekers are free to take this article at face value, however.

Even if you follow these ten suggestions, you may still not be audited. The exact formula used by the IRS for picking victims is unclear. But those wishing to invite additional stress are welcome to give these a try and report back with their results.

1. Earn more than $200,000. Taxpayers who report income above this level are 50% more likely to be audited.

2. File a loss on Schedule C. Self-employed individuals are already targets for audits, but if you want to increase your chances, report a net loss year after year. Either your business is losing money or you are finding deductions that bring your taxable income below zero; in both situations, you might invite more scrutiny by the IRS.

3. Be selflessly charitable. The government wants you to give your money to worthy causes, but only to a certain extent. If you claim charitable expense deductions that approach your level of income, the IRS will view your return suspiciously. Donating 10% of your income rarely causes a problem, but donating 90% might raise the red flag you’re looking for.

4. Hire your family members. For taxpayers operating a small business, payments to employees are considered deductions. The IRS pays attention when you hire your family members and write off their salaries as deductions. You may have to prove that your relatives are actually working if you want to survive an audit.

5. File your taxes by hand. Using tax preparation software helps to eliminate some of the basic mathematical and transcription errors that are common in hand-written returns. You may not want to intentionally include miscalculations or the wrong Social Security number, but the chances of doing so are increased when you use paper and a pencil.

6. Open overseas bank accounts. Wealthy individuals often use overseas bank accounts to hide assets and investment income from the United States government. Hiding is more difficult now that the government has successfully pressured certain foreign governments and banks to cooperate. If the IRS finds out about your foreign bank account, you could be audited and required to pay penalties.

7. Receive your income in cash. Consider becoming a professional gambler, waiter, or eBay store proprietor. Working in a job where you receive most of your income in cash is a signal that you have the opportunity to hide income from the government.

8. Round your numbers. If the IRS notices that your income and deductions fall neatly on round numbers like $50,000 or $2,000, you are inviting additional scrutiny. Even if you round in an unfavorable direction from your perspective, the government will be interested.

9. Transfer large amounts from your business savings to your personal savings. Banks must report all deposits over $10,000 to the federal government. They will also report deposits of $5,000 or more if the bank teller or manager has a reason to believe the money is coming from a less than reputable source.

10. Refuse to write off common deductions. If you operate a business, the IRS expects your deductions to look like most business that operate in a similar capacity. For example, certain business owners who do not claim deductions for travel may leave the IRS wondering what else has been left out of the tax return.

I am not condoning lying on your tax return, whether to avoid or to welcome an audit. As I mentioned above, I would prefer to avoid being audited by the IRS, so I will work with my accountant to make sure I have no red flags without detailed substantiation. These suggestions above are only for those who wish to bring difficulty into their lives by inviting the IRS into their homes.

Photo credit: Robert S. Donovan

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Last year, I mentioned my accountant saved me $15,000 by re-classifying my self-employment income from a limited liability corporation (LLC) to an S-corporation. I glossed over the process; in fact, getting to the $15,000 in tax savings was a bit more complicated than simply filing as an S-corporation. I could likely have saved even more if it hadn’t been too late to re-classify prior years, as well, or if I had worked with an accountant from the beginning.

I’ll share some details now so that readers — those with self-employment income, whether from a blog or otherwise — can determine whether this is the right choice for them. Keep in mind I am not an accountant or tax professional. Always discuss your particular situation with a tax accountant who will help you come to the right decisions.

An S-corporation is a type of legal business entity that, like LLCs or partnerships, allow all income or losses from a business to be passed along to shareholders and included in personal income tax returns. The biggest benefit, unlike LLCs or partnerships, is that not all business income needs to be passed to the owners as salary or wages.

For example, if you are the only shareholder, you could assign yourself a reasonable salary. You would owe self-employment tax on only this salary, not on your full business income. The remainder of your business profit will still be added to your personal income. You will owe income taxes on the full profit of the business, but only owe additional self-employment tax on the amount you designate as salary.

There are a few disadvantages for filing your business taxes as an S-corporation. The amount of necessary paperwork increases. If you’re busy running your business, you may not have time to deal with this. I’m glad I have a tax accountant to advise me and handle the paperwork. Considering the amount of money I saved, he has been worth his fee.

Filing as an S-corporation may make you more vulnerable to IRS audits, so ensure you’ve fully documented your income and deductions.

To create an S-corporation, complete your state’s process for incorporation and acquire a federal tax identification number. If you’ve already incorporated, or if you’ve formed an LLC, you do not need to re-incorporate, but ensure your state’s rules for your entity type meet your needs. File IRS form 2553 to elect S-corporation status.

When you file your taxes each year, rather than completing the form 1040 Schedule C, use form 1120S and Schedule K-1. Form 1120S is due before personal income taxes, so ensure your documentation has been sent in, or your extension request has been filed, by March 15 every year. Don’t forget to check your state filing requirements, too.

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