The threat of an IRS Audit can invoke the most intimidating feelings possible. If you are unfortunate enough to be chosen for this unwanted engagement, your experience will most likely be time consuming and costly.
Although the IRS audits less than 1% of all individual tax returns annually, your chances of being audited increases when you no longer fly under the radar. Of course, there can be legitimate reasons for significant financial changes to your tax return, but having the proper documentation and keeping good records that support your entries will ease the pain of any audit. But, the best case scenario is to avoid practices which lead to audit selection. Below, I’ve highlighted 15 red flags on a tax return that increase your chances of being singled out for an IRS Audit:
1 Home Office Deduction
Like LeBron James attempting a layup, the IRS knows they have a high probability of scoring when targeting returns that claim home office write-offs. Historically, the IRS have found great success knocking down the deduction, and driving up the amount of tax collected for the government.
Beginning last year with 2013 returns, the IRS created a simplified option for claiming this deduction. The write-off can be based on a standard rate of $5 per square foot of space used for business, with a maximum deduction of $1,500.
2 State Reported Income Doesn’t Match Your Federal
There is an expectation that the income you report on your state return will match the income reported on your federal return. If the IRS finds an error, they most likely will question the accuracy of your overall return.
3 Drastic Income Changes
The odds of being audited increase dramatically as your income goes up. Recent IRS statistics show that people with incomes of $200,000 or higher had an audit rate of 3.70%, or one out of every 27 returns. Reporting $1 million or more in income? There’s a one-in-eight chance your return will be audited. I’m not discouraging you from achieving financial success, but just understand that the more income shown on your return, the more likely you’ll be hearing from the IRS.
4 Income From A Job, Plus A Schedule ‘C’ Showing A Loss
If you’re working full time and report income from a W-2, plus have a side business or hobby that loses money (reported on Schedule C), get ready for a few questions. This is a strong audit flag.
5 Deductions For Employee Expenses
Big deductions for meals, travel and entertainment are always ripe for an audit. A large write-off here will set off alarm bells, especially if the amount seems too high for the business.
6 Exaggerated Charitable Contributions
I still believe it’s better to give than to receive. However, if your charitable deductions are disproportionately large compared to your income, it raises a red flag.
7 Big Round Numbers
Agents rarely see big round numbers, so claiming exactly $3,000 in charitable deductions will probably get your return flagged for an audit.
8 Income From Offshore Accounts
We should all be so lucky. If you had income from an offshore account, or venture, you’re still required to report it to the IRS. If you don’t, you could be subject to penalties and interest. However, just having offshore income could flag your return for an audit.
9 Puzzlingly Low Income
Ever wonder why you’re asked what your profession is on the bottom of your return? If you list income that is abnormally low for your profession, you’re likely to be flagged for an audit. Obstetricians usually make more than $27,500/yr and the IRS knows it.
10 Off The Chart Itemization
Again, you’re expected to fit within a certain profile. If you make $45,000, but have $52,000 in itemized deductions, that isn’t normal! If those are legitimate deductions, by all means take them. But know up front that you may trigger an audit flag.
They can be as simple as a name change due to marriage, or as complex as a carry back of net operating losses, which brought this year’s income down to zero. Either way, inconsistencies stand out and the IRS will take note.
12 Too Many Dependents
You can only support just SO many people, so make certain you’re not claiming someone on YOUR return that is also being claimed by another taxpayer.
13 Under Reported Income
A large percentage of my clients initially ran into trouble with the IRS due to misreporting issues. The IRS receives copies of all 1099s, and W-2s issued to you, so make sure you report this income. IRS computers are great at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag, and causes the IRS computers to spit out a bill. If you receive a 1099 showing income that isn’t yours, or listing incorrect income, get the issuer to file a corrected form with the IRS.
14 Claiming 100% Of Business Usage of Vehicle
When you depreciate a car, you have to list on Form 4562 the percentage of its use during the year that was for business. Claiming 100% business use of an automobile is red meat for IRS agents. IRS agents are trained to focus on this issue and will scrutinize your records. Make sure you keep detailed mileage logs, and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for the revenue agent to disallow your deduction. As a reminder, if you use the IRS’ standard mileage rate, you cannot also claim actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has seen such shenanigans, and is on the lookout for more.
15 Engaging In Large Cash Transactions
The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious-activity reports from banks and disclosures of foreign accounts. So if you make large cash purchases or deposits, be prepared for IRS scrutiny. Also, be aware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as persons depositing $9,500 in cash one day, and an additional $9,500 in cash two days later).
If deductions on your return are disproportionately large compared with your income, the IRS may pull your return for review. But if you have the proper documentation for your deduction, don’t be afraid to claim it. There’s no reason to ever pay the IRS more taxes than you actually owe.