AUDIT TRIGGERS: Know them to prevent an Audit
While the number of audits has dropped dramatically in recent years, the IRS knows that every $1 spent on audits brings in $4 to the Treasury Department. Tax experts know just what the IRS is looking for when it’s considering an audit and how you can trigger an audit through mistakes, oversights, and deductions.
Deviating from the norm, The IRS admits that it needs only a single anomaly to audit.
The IRS uses a system called the Discriminant Information Function (DIF) to scan every tax return for anomalies, mistakes, or deductions that seem out of place. For example, it can automatically see whether multiple people claimed the same children as dependents.
The DIF compares your tax return to those of people with similar income (or in similar industries if you’re self-employed). Anything on your tax return that’s outside the norm can cause the DIF to flag your return. If that happens, a human will have to review your return, and they may refer you for an audit.
You Have Missing Income
One of the most common IRS audit triggers is income that’s missing from your tax return. Nearly all income, including wages, capital gains, dividends, interest, or miscellaneous income must be reported. Other sources may report this information about you to the IRS, raising a red flag if your tax return doesn’t match.
For example, the IRS receives copies of all W-2 Forms, as well as 1099s reporting freelance/self-employed income. Or they receive 1099 Forms from stock exchanges and many cryptocurrency exchanges. They even receive reports on gambling or lottery winnings. They have other ways of tracking down income, too, so be sure to account for every penny.
Investors in stocks, bonds, real estate, cryptocurrency or other types of investments should be extra careful with their tax reporting; each additional source of income adds more potential for error. If you need help with a complex tax return, contact our experienced tax attorneys.
- If your earnings suddenly plummet by about half, that could be a trigger for the IRS, as well.
- Filing a sloppy return with Math Errors and Typos. According to the IRS, folks who do their taxes on paper are opt to get audited than those who e-file or get help.
The IRS has programs that check the math and calculations on tax returns. If your return “doesn’t add up,” it may be flagged for further review. Double check your social security numbers – and your math.
- Forgetting an old retirement account
- If your losses are greater than your gains, you can use up to $3,000 of loss to reduce your other income and carry over the amount above $3,000 to future years,” she says. However, if your investments are already tax sheltered, either in a retirement plan or in another place where the IRS can’t access them.
- Messing with Foreign Accounts There are few ways to avoid an audit in this situation. Overseas banks must identify American asset holders and provide information to the IRS. If you have at least $50,000,you must file form 8938 and let the IRS know what you have. You also must identify the bank and the highest dollar amount the account was at the previous year. If you comply, there’s a chance you’ll get audited just for having an account. If you don’t, you’ll pay penalties and maybe get a court date out of it.
You Amended Your Return to Lower Taxable Income
We have not found that filing an amended tax return increases the risk of an audit. This is especially true if you’re amending to report more income. However, if you amend your tax return to lower your tax liability. If you want to amend a prior year tax return, your attorney can help you understand the pros and cons for your specific situation.
Making Large Cash Payments or Deposits
Another potential IRS audit trigger is making large cash payments or depositing large amounts of cash in the bank. When any individual or business receives a cash payment of $10,000 or more, they must fill out Form 8300 reporting the transaction to the IRS. The form includes the name and address of the person who made the payment or deposit. If you’re identified to the IRS this way, that could be a red flag for an audit, especially if it doesn’t make sense for you to have that type of cash on hand based on the income you reported.
Audit by Association
Finally, if you’re financially involved with another individual or business that’s been audited, the IRS may uncover your information during the examination and decide to audit you too.
Excessive Deductions
The IRS will compare your itemized deductions to the average total deductions for a given item claimed by other taxpayers who are in the same income range as you. A taxpayer whose deductions appear to exceed these averages may be further scrutinized by the IRS. Don’t hesitate to claim every deduction that you are entitled to. Make sure you have the proper documentation.
Schedule C Filers
The IRS particularly watches for businesses that operate primarily with cash. And almost certainly those that are reporting a loss. They have lots of experience auditing self-employed taxpayers who underreport income or overstate expenses. Just make sure your records support what you are reporting.
Claiming 100% Business Use of a Vehicle. Using a vehicle, they own for 100% of the time for business purposes. And, if you don’t have another personal vehicle registered in your name, it’s nearly impossible to report that the vehicle is exclusively used for business. Claiming 100% business use of a vehicle will almost certainly draw IRS attention. The higher percentage you are claiming, the more critical it is that you have detailed records.
Claiming a Loss on a Hobby
Writing off expenses for a business is fine. You can’t portray your hobby as a business. For it to be a business, you must have a reasonable expectation to make a profit. The IRS will expect you to report a profit for 3 of every 5 years you operate the business. If you report your hobby as a business, it must be run like a business, with appropriate records and documentation. Otherwise, the IRS could require you to restate any business income/loss as a hobby income/loss, subject to hobby rules.
Home Office Deduction
To claim the Home Office Deduction, you must use a portion of your home “regularly and exclusively” for business. Keep in mind that the IRS doesn’t see the dining room table as a desk! And, having a TV in the “home office” could raise exclusivity questions. Most importantly, home office deductions from a person earning wages may draw increased attention, so make sure home office expenses are well-documented and supported.
Deducting Business Meals, Travel and Entertainment
This is another area that draws IRS attention because of past abuse. First, it’s probably obvious that you can’t deduct expenses for which your employer reimburses you. Second, you must keep careful records – not just a receipt, but also a record of who was in attendance and the specific business purpose. The IRS doesn’t want you enjoying lavish meals and entertainment on Uncle Sam’s dime.
Earned Income Tax Credit (EITC)
The IRS estimates that billions of dollars of EITC claims are paid in error. Some errors are unintentional, but the IRS scrutinizes EITC claims closely to prevent fraud. If you claim the Earned Income Tax Credit, make sure to document how you meet EITC rules so that you can provide this documentation to the IRS in the future.
Dealing in Cryptocurrency and Other Virtual Currency
There’s less government regulation over cryptocurrency like Bitcoin and Ethereum than over regular currency. They open doors to potential fraud opportunities. The IRS has created a compliance campaign that’s focused exclusively on cryptocurrency transactions and beefed-up enforcement to address abuse of virtual currencies. info@onealcpa.net
