No one loves doing their taxes. However, it is a necessity that we all must endure. Getting audited can make it all worse. If you’re the target of an IRS inquiry, you can be facing months of scrutiny and extra paperwork.
Perhaps, even a higher tax bill when all is said and done. Yet, it does not have to be this way. You just need to make sure to report all your income accurately. Additionally, dot all those I’s and cross all of those T’s properly where your deductions are concerned.
There is some good news, however. According to IRS commissioner John Koskinen, less than 1% of all returns submitted to the IRS were subject to an audit. That makes the odds pretty good. You most likely will not have to deal with the long and arduous process of getting your finances picked over with a fine-tooth comb by the government.
Though, even with those long odds of being among the 1%, you can still be selected for the dreaded audit. If your return sets off one more trigger, it will undoubtedly get the attention of the IRS. The key is to avoid these triggers at all costs. Do not worry. Most of these audit triggers can be easily avoided. That is as long as you are being up front and honest about reporting all of your income and your deductions properly.
The IRS has a system set up for deciding which returns will bear further investigation. We are going to review the various ways in which you can be red flagged. Doing so can prevent an audit. Those triggers can also vary dependent upon the type of return you’re submitting.
Filing as an individual taxpayer comes with different tax audit triggers than if you are filing as a small-business owner. That is why we’re going to cover both in this article. Therefore you will be well-apprised of all the potential triggers that might apply to your particular situation.
In the end, you may take every precaution possible. You may report all of your information with accuracy, do everything that was expected of you and still get audited. That’s okay too. The IRS sometimes chooses returns at random for additional observation through no fault of yours in any way.
Tax Audit Triggers for Individual Taxpayers
The IRS may select your return for an audit due to any number of potential reasons. There are seven triggers that will undoubtedly raise their suspicions enough to put yours under a microscope. Some of these are obvious.
Others may seem inconspicuous enough. They raise a red flag without you realizing nonetheless. That is why we are going to tell you about them here. Thus, you do not make some of the mistakes that are commonly committed by most taxpayers each year.
First and foremost, be sure to have all of your supporting paperwork and documentation. You will need to back up anything you may claim on your return. That is the best way to ensure that any audit you may be facing is short and painless. That is even if you do mistakenly commit some of these common tax audit triggers.
Fail to Report All Income
This one is pretty self-explanatory. It is the most common way to become the subject of an IRS audit. Additional monies in any amount from any possible source other than your primary employment or other reported method of income on your return must also be disclosed.
Maybe you fail to report a few hundred bucks a month. If the IRS discovers this secret little revenue stream you could be facing more than just an audit. It could result in a huge tax bill. They will demand taxes owed on that money. That is particularly so if you have been receiving this money on a steady, long-term basis.
The IRS could demand back taxes on that income for a minimum of seven years, if not longer. It is based upon the extent of time that you have failed to report this additional income. In addition to a hefty tax bill, failing to report all of your income could also result in criminal penalties. They are for offenders who have been neglecting to disclose substantial sums of income over a course of many years.
Reporting major financial losses due to a failed business venture will not always get you audited. Consequently, depending on how much you report losing for the year, it may certainly get you noticed. That’s why it’s critical to be careful about how you report. You must have the proper documentation to back it all up.
The IRS has come across too many taxpayers who have padded their losses in an effort to lower the amount they owe. These are losses that are only shown on paper. They weren’t actually incurred by the taxpayer. That is because they were centered on losses from hobbies and other non-business ventures that a taxpayer tries to pass off as legitimate.
If you’re submitting a Schedule C or Schedule E to report your losses, be sure that your claims can stand up to close scrutiny. Otherwise, you could be on the hook for substantially more tax debt.
Claiming Suspicious Deductions
This is just simple common sense. We all want to take as many deductions as possible to reduce how much we may owe in taxes. There is a myriad of ways that are available through the tax code. However, some taxpayers get a little too creative in claiming their deductions. That can bring on an audit.
If you are going to claim any deductions, be sure you are truly entitled to claim them. Most importantly, have thorough paperwork to support your claims. Donations to charitable organizations can be particularly suspicious if a taxpayer claims high amounts for those deductions.
There’s nothing wrong with having large sums of charitable donations on your return, as long as those claims are completely valid. That means having accompanying documentation to prove your charitable contributions are really made. The same goes for any other high amounts with personal or business expense deductions. That is in addition to other areas where your tax liability has been reduced.
Retirement Account Distributions
We all want to know how to retire early. For many filers, that means saving money through a variety of investment vehicles. One of the more recently prevalent ways that taxpayers file incorrectly is through reporting early distributions from investment retirement accounts (IRA’s) and other similar savings plans.
There are very specific rules for taking early withdrawals from certain types of accounts. Therefore, you need to be sure you report this money accurately. Otherwise, you could be subject to penalties and a higher tax bill.
Perhaps you take early withdrawals on your money. In that case, you must be certain it adheres to one of the eligible exemptions from being taxed. You will need to have the necessary paperwork to back it up.
Reporting Offshore Income
You may be thinking that the money you’ve got holed up in an offshore account. Maybe you believe income you’re making from overseas investments is safe from being taxed. Well, think again.
Any foreign-based accounts with a minimum of $50,000 in U.S. dollars must be included on your return each year. That also means you will need to pay what you owe to the IRS. It doesn’t matter whether or not you’re out of the country at the time you are expected to file.
Real Estate Losses
A possible red flag may get raised with writing off losses in a number of large sums of money. Similarly, the IRS is also watching for losses on rental real estate reported by taxpayers. Consequently, those filers who aren’t actual real estate professionals are considered to be earning passive income on rental properties.
That limits the deductions that might be taken by a taxpayer. They become expenses associated with rental real estate activities only. Perhaps you are actively involved in the business of renting real estate property. Subsequently, you could be eligible to take deductions on any applicable losses in their entirety.
Earning a Large Income
It may sound strange but it’s true. You are more likely to be audited if your income level rises above a certain level for that year. Plus, it’s even more possible to receive an audit if your income is significantly greater for the current filing year than the previous one.
This is due to the fact that the money reported on your return could mean more taxes taken out of your income than what was declared. It’s their way of double-checking that all of your math is correct.
Tax Audit Triggers for Small-Business Owners
There are even more ways to trigger an audit from the IRS. They are prompted when filing a return on behalf of a small business or if you happen to be self-employed. In some cases, getting audited on your business taxes can be an even bigger headache than one placed on your personal tax return.
The potential for an audit is also slightly more pronounced for business returns. That is due to the internal assessment program that the IRS employs in these matters. They rely on a software protocol called the Discriminate Function System.
It is an automated program that evaluates every return. It determines if an audit should be conducted. It is based on a statistical algorithm that scores each one it examines. Those returns that are given high scores are then analyzed by IRS agents. They will decide if they should pursue the matter or let the return go as is.
You can avoid getting flagged by the Discriminate Function System. There are some steps you can take to ensure you’re not committing the most common tax audit triggers on small business tax returns.
Claiming Wildly Disparate Deductions
As with the deductions taken by individual filers, small business owners and the self-employed have numerous opportunities for reducing their taxable income. However, if you claim amounts on your deductions that aren’t commensurate with your income, a red flag could be raised with the IRS.
The agency relies on internal assessment tables that suggest which deductions are most applicable to certain tax brackets. Therefore, let’s say you declare a small amount of income on your return but claim huge deductions that are disproportionate to that amount. It’s going to make someone at the IRS sit up and take notice.
That isn’t to suggest there aren’t instances where a business can declare a small income with large deductions. The first year or two of a business being formed might have such a ratio. Be careful that you are only taking deductions to which you are entitled.
Be sure you also have plenty of corroborating documentation for those large deductions being claimed on smaller income levels. This is especially necessary when the deductions you are claiming center on pricey expenses.
These include things like fancy dinners and other entertainment costs. It could be travel reservations that are only loosely related to your work. This is in addition to any other potentially questionable deductions.
Claiming Deduction on a Home Office
There are a few ways in which deductions can trigger an IRS audit of your taxes. Disproportionate deductions are one. Claiming deductions on the use of a home office is another. The IRS provides specific eligibility standards for claiming the use of your home for business purposes.
Be sure that the area used for your home office is not a portion of the room that can be deemed useful for personal reasons as well. That means you can’t claim a part of the living room or an area of your bedroom as a home office. The part of your home that serves as a home office must be used solely for that reason. It cannot be utilized for anything else.
Think about that before you take the deduction. Make certain that your home office is really just that, otherwise you could get audited. It also goes for any expenses while operating your home office. Thus, if you want to save on your electric bill don’t look for creative ways to claim deductions for which you may not be eligible.
Taking Deductions on Extravagant Expenses
Writing off expenses is perfectly acceptable when you own your own business. Nonetheless, be careful about claiming deductions on expenses that go well beyond the norm. Trying to write off expenses that have a tenuous connection to your business is almost always going to result in an audit of your taxes.
Maybe you’re thinking about taking your customers out to that five-star restaurant. Perhaps you want to spring for those hard to get theater tickets as a way to impress a prospective client. Think before you decide to deduct those costs from your taxes.
There are other entertainment expenses that you can rightfully claim. Therefore, be sure to have all of your receipts and clear and concise record-keeping for each expense. That way you can stand up to an audit should your return be flagged for business deductions. In those cases, business entertainment, travel, and other related expenses might appear higher than normal.
Taking Deductions for Vehicle Use
Perhaps your personal vehicle is being used for business purposes throughout the week. The IRS allows you to claim that usage on your taxes as a write-off. However, as you’ve probably realized by now, when it comes to deductions on your business taxes you need to meet certain requirements.
You must have a thorough accounting of your claims with corroborating paperwork. Otherwise, you could be facing a higher tax liability. That is in addition to penalties for taking deductions that you weren’t entitled to claim. It’s no different with claiming your vehicle for business purposes.
The distinction comes in claiming 100% business use on the depreciation of your vehicle. Should you choose to do so, you will need to have very thorough documentation of your mileage driven per trip. Plus, you will need to prove reasons for the trip and dates of use.
All deductions aside from claiming business use of your car lets you take your selection of the IRS’ standard mileage rate or the actual expenses made on the car. You may not claim both. If you do, that will most definitely bring on an IRS audit.
Choosing the standard rate takes some of the hard work off you when it comes to itemizing it all. The other method will require you to keep impeccable records on every expense incurred. They include gas receipts, maintenance costs, and anything else related to the operation of the vehicle for business.
Be sure to keep all the driving for business. Don’t do personal errands or make any other non-business related trips. If you do, don’t include those trips in your deductions.
Perhaps your returns continue to reflect consistent losses each year. In that case, the IRS may start to get suspicious. That, in turn, will certainly bring about an audit. Many filers claim business losses on their tax returns. Those individuals will sometimes incorporate losses related to expenses spent on a hobby that isn’t directly related to their business.
Some filers will try to claim a hobby as their business in order to write off those losses. These actions are a violation of the tax code. In addition to being subject to an audit, you could be facing criminal penalties. Claiming losses on your business is not illegal. It may be warranted in appropriate cases. Nevertheless, be certain that your claims are within compliance of the law and the business is perfectly legitimate.
Don’t Round Up
We all do it. Round up (or down) when we talk about money. It’s perfectly okay to do it in casual conversation or other environments. Ergo, doing it on your tax return can be an automatic trigger for an audit. Every penny counts when it comes to reporting your income.
Hence, if you can declare $503.26 but list it at an even $500, it can be problematic for you. It makes the IRS feel like you could be hiding some of your income. That makes them think you have been careless in other facets of filling out your return. A little rounding is acceptable, as long as you keep it only to cents such as turning $24.86 to $25.00 — but it’s best to try to avoid it altogether if you can.
Check Your Math
You don’t have to be an expert at doing mathematics. It’s okay if you mess up a number or two, but if your return is fraught with dodgy addition and subtraction, the IRS may decide to audit. We’ve already talked about rounding your numbers up or down.
That will also trigger some closer scrutiny into your taxes. Go over your calculations with a calculator once or twice before handing in your return. It will go a long way in helping you avoid the dreaded audit.
Now, there are so many online tax software options available. Thus, the heavy lifting is done for you when it comes to your math. These programs do all of the necessary calculations. They base it on the data you enter. In turn, you don’t need to wonder if you’ve carried the one or not.
Our Final Thoughts
Doing your taxes is no one’s idea of a good time. All the same, do everything correctly the first time. Then, you need to not be concerned with triggering an audit. It’s also no secret that the IRS tax code is about as long-winded and complicated as they come. Plus, the laws change each year.
That can make it tough to know whether or not you’re in total compliance with all of the current rules. Maybe you are still unsure. It’s best to read up on the recent regulations. Also, talk to a tax professional. They can advise how to ensure you are reporting all of your income and deductions with total accuracy and transparency.
Be sure you have all of your paperwork and supporting documentation. You’ll need it to back up all claims and declarations listed on your return. In the event you do find yourself facing an audit, you want all of your information organized. In doing so, you can present a strong case to the IRS.