When it comes to income taxes, no one wants to pay one penny more than necessary and, certainly, no one wants to invite the IRS to examine the return. After more than 35 years in dealing with taxes, here are my five rules to follow to make sure that taxes are minimized legally and safely so you can sleep at night.

Rule 1: Report all income
Unless there is a special tax rule allowing income to be fully or partially excluded, be sure to report all income. This includes not only items reported to you (and the IRS) on information returns (such as 1099s and Schedule K-1s), but income from other sources, including tips, bartering in your business, and cancellation of debt in most cases. If you fail to report income and the IRS finds out, you can be subject to civil penalties, or even worse, criminal sanctions.

Rule 2: Watch deadlines
The tax law is a minefield of dates by which certain actions must occur. You have to file by this date or take action by that date. Missing a deadline can result in penalties. Perhaps even worse, it can cause you to lose out on opportunities you would otherwise be eligible for. For instance, if you receive a distribution from an IRA and want to make a rollover, it must be completed within 60 days or the distribution becomes taxable and no rollover is allowed.

Rule 3: Don’t deduct it if you’re not entitled to
Sure, there are open questions about certain write-offs, and more aggressive people may feel comfortable taking chances. Remember, that if you’re going for tax happiness (and a good night’s sleep), don’t play the audit odds; rely on what you can substantiate and defend.

I’ve seen people, for example, deduct their dog’s vet bills as medical expenses because the check was payable to a doctor. As my mother always said, just because someone is doing it, doesn’t make it right! Most small business owners use paid tax preparers, so work closely with yours to ensure that you’re coloring within the lines.

Rule 4: Keep records
The most boring thing to do is keep track of expenses and other costs for tax purposes. The sad thing is that without records, you may lose out on deductions that you would otherwise have been allowed to claim, or have to report more gains than you really had. Examples:

  • You use your personal car for business driving but you don’t keep track of the trips for business. You can’t deduct any car-related costs.
  • You bought property several years ago but don’t remember what you paid and have no way of showing your cost. When you sell, all of the proceeds are gains because you have no basis to subtract.

Fortunately, you no longer have to be a Bob Cratchit and keep paper ledgers and receipts. You can use apps and other devices to maintain the tax records you need. For example, I’ve been using Intuit’s Tap2Trac to record my business driving (it’s now been discontinued). An alternative is MileBug, but there are dozens of other helpful mileage tracker apps.

While some records can be discarded after a while, always keep a copy of your return along with proof of filing (a certified receipt for a paper return or a printout of the IRS acknowledgment for an e-filed return). The government has an unlimited amount of time to question a return if one had not been filed, so retaining this record will help prove you filed the return and end any further inquiry.

Rule 5: Watch for tax changes
While the Constitution is static, with only 27 amendments in 223 years since ratification, tax laws are constantly changing. Congress makes numerous changes every year (the number of pages in the Tax Code  went from 19,500 in 1974 when I started to follow tax law to 72,536 in 2011). And the IRS and courts add their views to what tax laws mean. If you don’t stay alert, you can easily miss out on opportunities that run for only a limited time.

Final word
As Donald Maclead, now CEO and Chairman of the Board of National Semiconductor said: “The only thing worse than paying income tax is not paying income tax.” In this economy, it’s the lucky ones who are concerned about taxes.