Ever wonder why some tax returns are audited by the IRS while most are ignored? The chances of you being audited or otherwise hearing from the IRS can increase depending upon various factors, including whether you omitted income, the types of deductions or losses claimed, certain credits taken, foreign asset holdings and math errors, just to name a few. Although there’s no sure way to avoid an IRS audit, you should be aware of red flags that could increase your chance of drawing some unwanted attention from the IRS. Here are the 12 most important ones:
Failure to report all taxable income.
The IRS receives copies of all 1099s and W-2s that you receive during a year, so make sure that you report all required income on your tax return.
Returns claiming the home-buyer credit.
First-time homebuyers and longtime homeowners who claimed the homebuyer credit should be prepared for IRS scrutiny. Make sure you submit proper documentation when taking this credit.
Claiming large charitable deductions.
This comes up again and again because the IRS has found abuse on audit, especially with those taking larger deductions.
Home office deduction.
The IRS is always very interested in this deduction, primarily because it has a pretty high adjustment rate on audit. Don’t be afraid to take the home-office deduction if you’re otherwise entitled to it.
Business meals, travel and entertainment.
Schedule C is a treasure trove of tax deductions for self-employed individuals. But it’s also a gold mine for IRS agents, who know from past experience that self-employed individuals tend to claim excessive deductions.
Claiming 100% business use of vehicle.
Another area that is ripe for IRS review is use of a business vehicle. When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use for an automobile on Schedule C is red flag for IRS agents.
Claiming a loss for a hobby activity.
Your chances of “winning” the audit lottery increase if you have wage income and file a Schedule C with large losses. And, if your Schedule C loss-generating activity sounds like a hobby, the IRS pays even more attention.
Small business owners, especially those in cash-intensive businesses…taxi drivers, car washes, bars, hair salons, restaurants and the like…are an easy target for IRS auditors.
Failure to report a foreign bank account.
The IRS is intensely interested in people with offshore accounts, especially those in tax havens. U.S. tax authorities have had some recent success in trying to get foreign banks (such as UBS in Switzerland) to disclose information on U.S. account holders.
Engaging in currency 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. Also, beware that banks and other institutions file reports on suspicious activities which appear to avoid the currency transaction rules (such as persons depositing $9,500 cash one day and an additional $9,500 cash two days later).
One of the biggest reasons that people receive a letter from the IRS is because of mathematical mistakes they make on their tax returns
Taking higher-than-average deductions.
If deductions on your return are disproportionately large compared to your income, the IRS audit formulas take this into account when selecting returns for examination.