With the Internal Revenue Service (IRS) increasingly cracking down on tax avoidance and evasion, taxpayers must be aware of potential audit red flags. Knowing which activities may raise flags with the IRS can help taxpayers avoid costly audits and ensure they comply with U.S. tax laws. This blog will discuss seven IRS audit red flags taxpayers should know, including unreported income, home office deductions, etc.
1. Unreported Income
The IRS receives copies of income documents such as W-2s, 1099s, and 1098s from employers, banks, and other payers. Any discrepancies between the records and what taxpayers report on their returns will be flagged for an audit. In addition to income documents, the IRS tracks income reported on Social Security and investment accounts and cash transactions. As such, taxpayers should report all sources of income on their returns.
2. Home Office Deductions
One of the most common red flags that can lead to an audit is claiming home office deductions. While claiming a home office deduction can be a great way to save on taxes, it’s essential to understand that the IRS is stringent regarding these deductions.
To claim a home office deduction, you must prove that you use a specific area of your home exclusively and regularly for business purposes. Furthermore, you must prove that you are using your home office to generate income. If you lack the documentation or proof to back up your claim, the IRS could decide to audit your taxes. Ensuring you have all the necessary paperwork and documents before claiming a home office deduction is essential.
3. Schedule C Filings
If you’re a small business owner filing a Schedule C with your taxes, you must know the potential audit red flags. One potential red flag could be a discrepancy between the total income reported on Schedule C and other sources like a bank statement. The IRS may question why the income said on Schedule C is lower than what was deposited in the bank.
Additionally, if you’re claiming business expenses, you must have the proper documentation to support them. This includes receipts, invoices, and other records. Any discrepancies between the expenses reported and the documentation you provide can trigger an audit. Finally, be aware of any errors or omissions on your Schedule C. If the IRS notices any discrepancies, they may question them and request additional information.
4. High Mileage Deductions
Taxpayers who claim high mileage deductions for their vehicles may be subject to an audit. The IRS requires taxpayers to keep accurate records of their mileage, including dates, destinations, and the purpose of the trip. Taxpayers should also be able to prove that their mileage is related to their business or employment.
5. Charitable Donations
The most common red flags related to charitable donations include a sudden increase in donations. This criterion also covers claiming donations for which there is no receipt and claiming donations that don’t come from a qualified charity. Being aware of these red flags when filing your taxes is essential. The IRS will likely audit your return if it sees any of these indicators.
A sudden increase in donations can be a red flag for the IRS. It can indicate that you are trying to take advantage of the tax benefits associated with charitable giving. Suppose you have made significantly more donations than in prior years. In that case, it is important to be able to provide the IRS with supporting documentation of how you came to make those donations.
6. Business Losses
Taxpayers who report large business losses may be subject to an audit. To avoid an audit, taxpayers should be able to prove that their losses are legitimate and that they are not using their business to evade taxes. Taxpayers should also be able to prove that their business is active and not simply a hobby.
7. Unusual Transactions
While most taxpayers are honest and comply with tax laws, certain red flags can trigger an audit. One of these red flags is the presence of unusual transactions. This can include sudden, large increases in income, large deductions, or multiple transfers between accounts. It can also include transactions that appear to be routed through offshore accounts, which is especially problematic since the IRS has recently been cracking down on international tax evasion.
It’s important to remember that an audit isn’t necessarily a sign of wrongdoing. The IRS may just be trying to verify the accuracy of your tax return. However, it’s still important to be aware of the potential for an audit if you engage in unusual transactions.