If just the title of this post is giving you heart palpitations, take a deep breath. Only about 0.45% of tax returns were audited in 2019. Your chances are very low that you will receive a letter from the IRS.
Still, there are a few red flags that could prompt the IRS to take a second look at your tax return, and it’s important to know what they are—because forewarned is forearmed.
- Failing to Report All Your Income
If you’re not reporting all your income, you could be in trouble. The IRS receives copies of all your 1099s and W-2s, and they have software that matches the income on those with what you report on your tax return. If something doesn’t match, the IRS will notice.
- Showing a Large Change in Income
The IRS may take a second look at your tax return if your income changes dramatically—in either direction.
- Taking Higher-Than-Usual Credits or Deductions
The IRS knows what the average credits and deductions are for someone in your income bracket. If yours are higher than normal, it might prompt the IRS to take a second look at your income tax return.
- Making Higher-Than-Usual Charitable Donations
Charitable donations are a big source of write-offs for many people. However, like with other deductions, the IRS has a pretty good idea what the average charitable deductions are for someone at your income level.
You should absolutely donate to charitable causes that are important to you, at whatever level you want—but be sure you have proper documentation ready just in case the IRS has questions about it.
Some specific charitable-giving missteps that might attract their attention include not filing an IRS form 8283 for non-cash deductions worth more than $500, or failing to get donated property of value properly appraised.
- Being Self-Employed
Sole proprietors are at particular risk of being audited—especially those who make over $100,000, as well as businesses known to do business in cash a lot such as beauty salons, restaurants and bars, car washes, and so on.
- Claiming Large Rental Losses in Real Estate
The IRS watches people claiming to be real estate professionals fairly carefully. It’s not uncommon for people to write off large chunks of rental losses while earning a regular paycheck at a full-time day job in a different profession—reducing their overall tax bill.
The IRS wants to limit these large write-offs to people who actually work in real estate as a profession. Usually, you’re allowed to take large deductions for renting out real estate property only under certain circumstances, such as:
- When you’re active and hands-on in renting the property, even if you have another job. When that’s the case, you’re allowed to deduct a certain amount in losses against other income you make. This amount shrinks as your adjusted gross income grows.
- When you’re actually a real estate professional. If you spend more than half your working hours or more than 750 working hours a year actively working as a real estate developer, landlord, or broker, you’re allowed to write off losses on a rental property.
- Writing Off Losses Connected to a Hobby
The IRS wants to avoid letting people write off losses for activities that don’t earn them money. Of course, a new business may not turn a profit for several years as well—but the IRS would like to differentiate between these two situations.
To make your deductions legal, you must be treating the activity like a business and have a reasonable expectation that this will become a profit-making endeavor at some point. In general, the IRS wants to see the activity earning a profit three out of every five years—the ratio may change slightly depending on the activity.
- Deducting Large Amounts for Meals or Travel
Food and travel deductions are an especial red flag for IRS auditors, especially if these don’t seem reasonable for the type of business you run. Any food or travel deductions should be thoroughly documented.
Entertainment costs used to fall into this category as well, but as of 2017, the IRS eliminated entertainment expense deductions altogether.
- Claiming a Home Office Deduction
If you’re self-employed and work from home, you’re usually allowed to claim a home office deduction. However, it has to meet strict IRS guidelines to qualify. The IRS wants to prevent people from taking the home office deduction just because they sometimes answer work emails on their couch.
If you qualify to take the home office deduction, make sure you do it right. There are a few different methods; a common one involves adding up your total residential expenses for the year and multiplying those by the percentage of your home that you use for business purposes.
For instance, if your home is 1,000 square feet and your home office is 100 square feet, you can multiply the total costs of maintaining your home by 10% and determine your deduction.
When you use this method, you can deduct indirect expenses—like repairing your gutters—by the same percentage of your home taken up by the home office. You can also deduct the whole cost of any expenses that only apply to your home office.
- Claiming 100% Use of a Vehicle for Business Purposes
Whenever you deduct a vehicle, you have to include information on the percentage of the time you used that vehicle for business.
If you claim you used the vehicle only for business, that could prompt the IRS to take a second look at your tax return—especially if you’re self-employed and you only have one vehicle.
If you’re using a large truck or SUV for business, that’s especially questionable to the IRS—especially if you bought that vehicle later in the year, as the timing could raise the amount of depreciation you can write off.
Are You Facing an IRS Audit? Hire a Qualified Atlanta Tax Attorney.
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