While nearly 150 million federal tax returns are filed each year, the IRS audits less than 1% of them. However, for those that do get caught in the government’s crosshairs, the audit process can be long and costly.
As unpleasant as an IRS audit can be, it won’t go away. It’s important to respond promptly. An experienced tax attorney trained in IRS audits can provide the response needed to clearly communicate your position to the IRS and help you address proposed penalties if there’s an adjustment.
With that stated, it’s infinitely better to avoid being audited in the first place.
15 Things That Commonly Trigger an IRS Audit
Number 1: Reporting the wrong taxable income – The IRS has already received your W-2 and 1099 forms from the companies that paid you last year. Therefore, it’s important to be completely honest when listing your taxable income on your tax return forms. It’s okay if you make a small error in math, the IRS is happy to correct it for you. However, fudging the numbers about how much you made is a great way to trigger an audit. To avoid this, compare the W-2 or 1099 you received against your own records and inform the company that sent it if you think it’s wrong, asking them to file a correction with the IRS.
Number 2: Huge donations on a small budget – Under the new tax reform bill, you can deduct up to 60% of your income in qualified charitable contributions if you itemize your deductions. However, if you don’t make much money, and you’re giving a large portion of it away, it can raise a red flag with the IRS. While it’s noble to give back, avoid the temptation of claiming to give more than you actually do to reap the tax advantages. To err on the side of caution, keep all charity receipts, file Form 8283 for any donation over $500, and have large donations appraised.
Number 3: Spending or depositing large sums of cash – Most businesses are required to notify the IRS for any cash transaction of $10,000 or more. If you spend or deposit a large amount of cash, the IRS will want to know where the money came from, especially if it doesn’t line up with the income you reported.
Number 4: Using your car for business – Using your vehicle for some part of your business can get tricky if you’re also using it for personal trips. It’s important to distinguish between the two by keeping meticulous records of your mileage, and calendar entries stating your starting and ending addresses, and the purpose for each time you use the car for business. You can also use technology, like your GPS data to back up your claims.
Number 5: Your home office – It’s fine to have a designated section of your home where you keep your computer, and other work supplies, and where you do the majority of your work. However, this area cannot be used for any other purpose, especially personal use. It’s important to note that employees who work from home can no longer deduct their home office expenses under the 2018 tax reform bill.
Number 6: Tax errors – One of the top reasons for audits is errors such as stating the wrong income, filing under the incorrect status, or improperly claiming deductions and credits. To avoid them, double check your work before filing and keep detailed records for deductions and credits.
Number 7: Round numbers – While rounding to the nearest dollar can be okay, if every year, your tax return includes perfectly round numbers, it can trigger an audit. The IRS may think you are either lying or doing some pretty sloppy record keeping. To be on the safe side, always use actual numbers, down to the penny.
Number 8: A business that loses money – Isn’t making money the point of having a business? While it’s always possible to have a bad year or two, reporting a loss in more than three of the last five years, can prompt the IRS to take a closer look at your operation.
Number 9: Too many deductions – The IRS has a lot of data to work with. They have software that can pull data from every business in the country and the average amounts of deductions taken. If your business falls way outside of those averages, it could result in an audit. A professional tax consultant can help file your taxes and warn you if you’re deducting too much. There are a number of deductions that are no longer allowed under the 2018 tax reform bill, including casualty and theft losses (except those attributable to a federally declared disaster), unreimbursed employee expenses, tax preparation expenses, alimony payments, moving expenses, employer-subsidized parking and transportation reimbursement, and miscellaneous work expenses, like travel or meals with clients.
Number 10: 1099 income – Independent contractors who have lots of small clients and receive several 1099 forms may be flagged, as the IRS could suspect you might not have reported all of your taxable income.
Number 11: Self-employment – The last few years have seen a lot of growth in the gig economy, with more and more people working for services like Uber and food delivery services. However, a lot of these people don’t understand that they are in business and need to file a Schedule C, or “profit or loss from business” like any other self-employed individual.
Number 12: Duplicate info – The IRS uses software that detects anomalies in your tax return. For example, if you claim a dependent and another tax pay also claims that same dependent, it could trigger an audit.
Number 13: Rental income – Those that have a 9 to 5 job and also collect rental income may score higher on the IRS’ audit scale due to the limits on the amount of losses you can claim.
Number 14: High earnings – The higher the income, the more likely the audit. Simply put, the IRS has more to gain by catching a wealthy person making a mistake on their taxes. However, low-income earners aren’t’ off the hook and can certainly be audited should any of the other triggers on this list come into play.
Number 15: International assets – If you have assets and cash stashed in other countries, especially in countries known for having more favorable tax laws than in the U.S., the IRS may take an interest. The U.S. government has been very aggressive in investigating and prosecuting people who don’t report income from offshore accounts and has very severe penalties in place. To avoid them, report all foreign accounts with total cumulative balances of more than $10,000 on FinCEN Form 114 and report all foreign assets valued at $50,000 or more on IRS Form 8938.
The Best Advice to Protect Yourself from an IRS Audit
The best way to protect yourself against a possible audit is to keep detailed records and receipts. Use technology to your advantage by having your receipts digitized and saved to a secure hard drive and encrypted and backed up to the cloud. Save at least six years of receipts, depending on the circumstances; the IRS can look back that far.
However, if they really believe you’ve defrauded the U.S. government, they can go all the way back to the day you filed your very first tax return.
If you’re facing an audit, it’s imperative you have an experienced tax lawyer to represent you before the IRS. Contact us to learn how we can help you.