Many people dread dealing with the Internal Revenue Service. Very few people actually like doing their taxes. In addition to the frustration of filing, the fear of being audited can actually cause you to overthink and miscalculate your taxes which will ultimately increase your risk of an audit. This is why it is important to know the potential “red flags” that alert the IRS to possible fraudulent claims and may lead to an audit.
Suspicious Activity That Can Lead to a Tax Audit
There is no limit to the number of audits the IRS can perform each year. Depending on budget restraints and yearly filings, some years can have fewer audits than others. In 2013, fewer IRS agents resulted in only 1% of filings being audited. Individual yearly income can have an effect on your audit chances as well, as the more you make, the more complicated the tax forms become, allowing for a greater chance of error.
- If you make under $200,000 a year, your chance for an audit is approximately 1%.
- If you make between $200,000 and $1 million, your chance increases to 3.26%.
- If you make more than $1 million, your chance increases to 10.85%.
In addition, making certain mistakes (intentional or otherwise) can drastically increase your chance for an audit as the IRS specifically looks for particular discrepancies. Therefore, before you file, you need to check and re-check your forms for any of the following red flags:
- Major changes in income from previous year. The IRS keeps records of previous tax forms and, if a large discrepancy occurs in your income, they may assume that you’re underreporting your earnings or didn’t keep track of all your wages. As a result, they may decide to audit you to discover the reason for the change.
- Lost or unfiled forms. No matter how many employers you may have had over the year, every single one should send a copy of your earnings (511s) to you and the IRS. Therefore, if the IRS has a copy of your 511 from your employer but not from you, they will wonder why and audit you to find out.
- Figures don’t add up. In addition to making sure you file your forms, the IRS uses copies of your 511 to compare figures. If their numbers don’t match with the numbers you filed, you miscalculated figures, or your numbers don’t logically add up, then an explanation will need to be investigated.
- Self-employment deductions. Self-employed taxpayers are usually red flagged due to their deductions and how they report their income. However, as long as you keep all documentation of transactions and are able to prove that your home office deductions (computer, partial rent space, etc.) are being used for the sole purpose of your work, you should be fine.
- High home office expense deductions. Whether you’re self-employed or not, when deducting home office expenses you need to be careful that you’re only deducting expenses specifically used for work. Just because you occasionally check your work email from home doesn’t mean you can deduct your computer as an office expense. However, if you have a specific computer dedicated to work, you may be able to deduct it.
- Hobby deductions. It’s good to have a hobby that you can use to unwind after work. However, unless that hobby brings in extra income you can’t use it as an excuse to deduct material expenses. Always keep receipts and transaction documentation to prove your hobby is a secondary income source when planning to deduct expenses.
- High social deductions. Although business expenses are allowed to a certain extent, if you make a habit of deducting expensive meals, travel, and entertainment, the IRS may feel the need to investigate to make sure all of the deductions were work-related.
- Miscellaneous itemized deductions. Too many miscellaneous deductions can quickly make the IRS uneasy about what you’re considering “miscellaneous.” Although it may be easier to group expenses together rather than listing every single expenditure, make sure you have all the receipts and documentation to prove each deduction individually in case of an audit.
- High charity donations. Although donations to charity are deductible, too many or excessively high donations may raise suspicion. For example if you claim that half of your yearly income went to charity, the IRS may not take your word for it and will need to investigate further.
- Off-shore accounts. The Foreign Account Tax Compliance Act has strict requirements when it comes to reporting foreign bank accounts. The law requires overseas banks to identify American asset holders and provide their information to the IRS. Therefore, if you withhold tax information from these accounts, the IRS will rightfully wonder why.
Avoiding the Stress of an Audit
Besides being extremely frustrating, an audit can cause the IRS to become intrusive in your family’s lives. A simple mistake can cost you time, freedom, and hundreds of dollars. Don’t allow your taxes to take more from you than you already give. Contact us today to get the experienced and dedicated help you and your family need before you risk an audit.