Four things you need to know to avoid a tax audit

Yes, I'll confess I've had taxes on my mind quite a bit lately. It's been a good year so far. I can't help but be a little concerned that estimated payments and withholding will be enough to keep me out of the penalty box. I'm also fairly diligent about our record keeping. I can't help but think that some of our financial ratios border on the extreme, and we all know it's the ratios the IRS looks at when deciding who to invite in for an audit.

If you've ever been through an audit you'll agree that any time of year is a good time to think about taxes too. If you've been audited recently you're probably thinking about them all year 'round. Spending a little time assessing your tax situation right now can alert you to potential problems while there is still time to correct them and avoid a trip to the auditor.

One of the best tools I have and make use of to keep the tax situation under control is the deductible donation to a qualified charity. Volunteerism, unfortunately, isn't deductible; but many of the costs involved are. I keep accurate records, using GnuCash, of all contributions, whether in cash or in kind. But knowing which expenses and contributions are deductible is the first and most important step.

Here are 4 things you need to know to avoid an audit triggered by deductions you claim for contributions to charity:

1. Make sure the organization you're donating to is a qualified organization, because if they are not all your contributions to that organization will be disqualified on your Schedule A - an audit trigger if there ever was one. How do you find out if an organization is qualified? Check IRS Publication 78, or better yet, go to the IRS web site and use the Search for Charities tool. You should also know that religious organizations - churches, synagogues, temples, mosques and such - along with certain government agencies won't be listed in Publication 78 even though they are eligible to receive deductible donations.
2. Anything you donate must be deducted in the year you make the donation. That means you can't call up and donate on December 31st using your credit card and then decide later on in which year to use that donation. If you charge a donation on 31-Dec-2007, it's a 2007 donation. True, you won't pay your credit card bill until sometime in 2008; but the IRS considers the donation made when the card was charged. If you're trying to accelerate donations before the close of the year, this works in your favor, because a simple phone call is all it takes.

   Donations made by check work the same way. Your donation takes place the day you mail the check.

3. You can only claim deductions on Schedule A. That means that in order to claim deductions for contributions you must itemize. If you choose to take a standard deduction, that's all the deduction you get, so if your contributions are significant you'll want to itemize.

   It works like this: Itemize your deductions if the sum total of donations to qualified organizations, mortgage interest, medical expenses, state and local taxes, etc. is higher than your standard deduction. If this is the case for you and you choose to file a short form 1040A or 1040EZ, you're paying too much tax!

4. Keep good records. All donations of property - and starting this year that includes clothing and household items - need to be documented to keep you safe at audit time. Unless I'm donating something of small enough value that I wouldn't lose sleep over should it be disallowed, I get a signed receipt and keep it in my yearly tax file.

It's your responsibility to claim deductions only for qualified contributions. It's also your responsibility to claim deductions for all of your qualified contributions. Even one mistake can greatly increase your chances for a tax audit. There is no substitute for a good working knowledge of what is and what is not deductible.