In this bad economy, the IRS has been steadily increasing audits of taxpayers. Although your chances of being audited by the IRS depend on a whole array of factors, there are certain actions and positions taken on income tax returns that might make you more likely to attract IRS scrutiny. What follows is a list of some of the most common audit triggers (but this list is not all inclusive by far).
1. Omitting Reported Income.
The IRS has very thorough computers that are excellent at matching all the tax forms you receive reporting your income (e.g., Form W-2s, Form 1099s for reporting dividends, interest and capital transactions) to what you actually report on your tax return. Failing to include these reported amounts on your tax returns is the quickest way to get audited.
2. Claiming Huge Charitable Deductions.
Claiming large charitable contributions often results in increased scrutiny to the return. Also note that tax rules require documentation of your gifts to nonprofit organizations. The IRS may demand you provide them with the documents substantiating these charitable deductions.
3. Taking a Large Home-Based Business Deduction Every Year.
The IRS might question whether a Schedule C business losing money year after year is a legitimate business. After all people go into business to make money, not lose money. The IRS may ask you to produce evidence of a profit motive.
4. Claiming Home Office Deductions.
Although it may be a perfectly legitimate expense that you shouldn’t shy away from, the home office deduction is a red flag that sometimes triggers a review. It is imperative that you seek the advice of a qualified tax professional to help you determine your allowable deduction amount. We also recommend that you keep meticulous records of all your expenses and be prepared to substantiate them
5. Claiming Large Deductions for Business Travel and Entertainment.
The IRS really loves to ask for back up documentation to substantiate these expenses as it is a commonly abused deduction.
6. Claiming 100% Business Usage of Your Car.
This is a huge red flag for the IRS. Once again, note that commuting expenses are not deductible.
7. Writing Off Big Unreimbursed Employee Business Expenses.
While some of these expenses are legit, they’re only deductible beyond 2% of adjusted gross income. Also, the IRS may think you are trying to write off disallowed items such as ordinary work clothes and commuting costs. The IRS may request documentation to support these deductions.
8. Claiming a Hobby Loss.
By definition, a hobby is not an activity pursued for profit; however, that doesn’t deter some people from trying to write off expenses for their hobbies. These rules surrounding hobby losses are very detailed and there is a wealth of case law dealing with hobby losses. Be careful in this arena. You may want to seek the advice of a qualified tax professional.
9. Claiming the First Time Home Buyer Credit.
Although the law allows legitimate first time home buyers to take this credit, many have abused this privilege. As a result, the IRS is examining such returns that take this credit very closely.
10. Failing to Disclose Offshore Accounts.
While it is not illegal to U.S. taxpayers to have foreign bank accounts, it is definitely illegal not to declare them. By now, if you are a U.S. taxpayer owning a foreign bank account, you’d have to be living on another planet not to have heard about the UBS debacle. If the IRS finds out, they will be after you.
11. Using Scumbag Tax Preparers.
The IRS is stepping up its efforts to monitor tax preparers and eliminate unethical sleazeballs. There are tax professionals out there that try to win your business by preparing your tax returns full of disallowed credits and deductions. When the IRS finds about a tax professional playing these games, his or her clients become easy targets for audits.
12. Taking Deductions in Round Numbers.
This may sound silly to you, but think about it – most legitimate entries on a tax return don’t end in zeros. If the IRS sees you taking many deductions ending in zeros, the IRS might suspect you don’t have the required documentation backing up these deductions and you risk an audit.
13. Making Errors in Math.
IRS computers are programmed to check your math. Math errors invite IRS scrutiny.
14. Making careless mistakes.
Careless mistakes like incorrectly entering your social security number or failing to sign a return are all red flags to the IRS.
15. Pissing the Wrong People Off.
The IRS has a whistleblower program that pays rewards to informants whose tips result in tax collections. If you anger an ex-business partner, ex-employee, or ex-spouse and they come forth with information that you have violated any of the tax laws, the IRS may come after you.
Protecting Yourself and Counteracting IRS Challenges to Positions on Your Return
KEEP METICULOUS DOCUMENTATION!!! We cannot stress this enough. The only way to fight the IRS on any challenges to these positions is to be able to justify them through sufficient documentation.
If you are currently the subject of an IRS examination, or you would like to discuss ways to protect yourself against an IRS audit, please contact us.