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January

Tax Audit Red Flags

The IRS audited less than 1% of individual tax returns last year, and is projected to audit even less this year. Consequently, the likelihood of the IRS questioning and reviewing your tax return for accuracy is slim. Math errors don’t curtail a full-blown investigation, and you should have nothing to worry about unless you’re falsifying tax information. Even so, the possibility of being audited depends on a variety of factors, including income level, the types and amount of deductions taken, business practice, and others, so there’s no way to consider yourself off the hook. 99% of contact from the IRS doesn’t pertain to something pleasant; avoid their unwanted attention by knowing the red flags that lead to audits.

Income & Business

A straightforward factor that can be a red flag is a high Income – $200,000 or over, and you’re much more likely to be audited, and the odds soar if you make over $1 million. Likewise, if you own a small business, and especially if it’s a cash-intensive business, you might fall under more scrutiny. These types of businesses are likely to exaggerate net losses on Schedule C and underreport income.

Failing to report all of your income is easiest to avoid, but easiest to misrepresent; anyone who gives you a W2 or 1099 also reports that to the IRS. They use a machine that matches those numbers pretty perfectly, and spits out a bill if those numbers don’t align. Gather your documents and punch all of the numbers a few times for an accurate sum.

Finally, there are those, who may have been doing so for a long time and are resistant to abide by new laws, who neglect to report foreign accounts. Although you now have to fill out Form 8938, there’s a perception that those with foreign accounts are trying to hide something. If you have a foreign account, especially with a high balance, trust in a tax professional to make sure all is well when reporting.

Deductions

In general, taking deductions far beyond your income is a huge flag to the IRS. However, if it’s documented, go for it, as special cases do occur. The most abused and blurry-lined deductions fall under business expenses; normally for meals, travel, and entertainment. The IRS has occupational codes for your position’s typical expenses. If you’re reporting 20% above this rate, beware. Claiming 100% business use of a vehicle is another separate, but less offended, red flag. The IRS knows this isn’t very likely, and if it is, will need mileage and calendar log documentation as proof.

Other, more specific and less common deductions also cause eyebrows to raise. Taking large charitable deductions that are disproportionate to your income is risky. The IRS also have average donation amounts for your income level. A less simple deduction that is often taken concerns alimony payments. The rules are complex, and the IRS is aware some who claim this write-off don’t qualify. Make sure you and your former spouse match in reporting. The home office deduction is also common; it’s a great deal if you meet the requirements, which many are unaware of. There’s a max deduction of $1,500, so the red flag isn’t too large, but the rule states that the space must exclusively and regularly be used as your primary place of business. Your couch or the coffee shop does not necessarily count.

Outliers

The IRS keeps a general eye out on other, more rare claims. Things like taking an early payout from an IRA or 401(k), or making large, excess cash transactions, are some example. Another pertains to gambling; if you fail to report winnings, or claim big losses, an investigation may occur. Documentation for everything is becoming increasingly necessary, especially if you know a claim or deduction you make on your taxes is less common or falls under peculiar circumstances. Audits by the IRS are fairly likely in general terms, but can be damaging in the form of tax evasion.