The good news is that, on average, very few people get audited by the IRS. Better still for some of us, the less money you make, the less likely you are to be audited. According to the IRS, for Tax Year 2009, if you made less than $200,000, you had a slightly lower than 1% chance of being audited. If you made more than $200,000, your odds jumped to almost 3%. If you earned over $1 million, bump that frequency up to over 6%.
The bad news is that the chance still exists for all of us, and despite the general professionalism of the IRS, an audit is rarely a pleasant experience. To avoid or , stay clear of these top 16 things that raise red flags with the IRS.
So often, Taxpayers ask why the CRA started an audit or whether taking a certain step may target them for a future audit. These are reasonable concerns, since the CRA’s method to audit selection isn’t generally random, but rather based on risk assessment.
An IRS audit can be a nightmare. Thankfully, only a small percentage of tax returns are audited. Wondering if your return is audit bait? It’s not black magic; the most egregious red flags are well known. Here are the top tax return warning signs to watch for and how to further reduce your chances of getting picked.
Particular red flags in a tax return are sure to attract scrutiny by the IRS. Some are simple to sidestep. Others, cannot be helped.
The Internal Revenue Service uses a combination of automated and human processes when selecting which tax returns to audit. Every tax return is compared with statistical norms, and those with irregularities undergo 3 layers of review by personnel. Audits then happen by either mail or in meetings at taxpayers’ places of business. They can be unpleasant and are sometimes unavoidable.
Tax Audit Red Flags & Triggers You Should Know
1. Math Errors
Your income tax return gets entered into an IRS computer, one way or another. If you have made a math error, you will automatically get the computer’s attention. This is one of the most common IRS audit triggers. This is why, if you do your own return, it may be a good idea to run it through a tax program to check your math.
2. Failing to report all taxable income
Another simple trigger to IRS audit is to report income differently on your return than the people who pay it to you report it, via W-2 form and 1099s. The IRS computer will try to match all of your payers’ numbers with your numbers, and when they can’t, you get a letter. So gather all of those envelopes stamped “IMPORTANT – TAX RETURN DOCUMENTS,” and tick off all of those numbers. . The most tempting audit red flag is when you don’t follow the law, such as failing to declare all of your taxable income. It’s not like you can easily hide it; after all, the IRS gets a copy of all of your W-2s and 1099s.
3. Not Just How Much, But Also How
As I noted above, your income level can affect your odds of being audited and raise a red flag, but how you earn that income is also relevant. People who work in jobs where a significant amount of unreported cash changes hands, such as restaurant wait staff or salon workers, garner more interest.
The CRA might start an audit on the basis of information gotten during the third party’s audit, or due to a referral from another CRA department, other government informants or organizations. Sometimes estranged family members share information with the CRA, which include estranged spouses looking for leverage in a family law dispute.
5. Not using fair market value for residential real estate rentals:
Where real estate rentals yield no losses or income, the CRA might suspect that the property’s being rented for fewer than market-value rent to a non-arm’s length person. The CRA might depend on interest expense and property tax information to ascertain the value and market rent for a property.
6. Discrepancies amongst tax filing position & filing positions for similarly situated taxpayers or private corporations:
The CRA might compare: corporate tax returns between similar businesses; the relationship of purchases, HST/GST and sales remitted to other businesses within the same industry to determine if remittances are reasonable; and tax returns of shareholders of a private corporation to the corporation’s tax filings. Thus, filing positions that aren’t consonant with expectations for an industry, or which aren’t consonant between shareholders & their private corporations, might attract an audit.
7. You have a sketchy tax preparer
From time to time, your tax preparer conducts something which could be the reason for an IRS audit trigger. If a preparer guarantees bizarrely high refunds without the need to ask to view proper documentation for credits and deductions, do not get tricked, mentioned Vincenzo Villamena, managing partner and CPA at accounting firm Online Taxman.
8. Typos and Entry Errors
It seems like a silly way to get audited, but if your numbers don’t match the numbers the IRS has on file, it raises a red flag for an audit. CPA Andrew Porter tells USA Today you should even double check numbers entered by a tax professional:
You’re legally responsible for the information on your return no matter what a preparer tells you, so make sure to look over your return before it’s sent to the IRS.
“Preparers can promise you the world, but then when they deduct a bunch of stuff they shouldn’t, you’re going to be the one stuck with an audit,” said Villamena. Also, you’ll be required to repay any money you receive fraudulently.
9. Making unusually high charitable deductions.
One of the benefits of reviewing millions of tax returns every year is that the government has access to statistical data that can accurately raise a red flag for IRS audit. For example, charitable donations that don’t conform to expected values for your income level. Not only should you be careful to accurately assess your charitable donations (such as if you give away personal property to Goodwill or similar organizations) but you should do it properly — such as filing for 8283 for donations over $500.
10. An anomalously high income.
If your income is very high, congratulations. And while there’s not much you can — or probably even want to — do about that, you should be aware that for incomes over $200,000, the audit rate is almost 4 times higher than the national average.
11.The Earned Income Tax Credit
Last year, the IRS said tax returns that claim the Earned Income Tax Credit are twice as likely to be audited. According to the Wall Street Journal, “improper claims” of this credit cost the government over $10 billion a year.
Sometimes these “improper claims” are fraud, but sometimes they’re honest errors:
“The EITC’s complex rules help lead to high error rates by taxpayers and even paid preparers.”
If you or your preparer has claimed the EITC, read the IRS guidelines and double-check that you qualify.
12. Claim a loss on a hobby.
By definition, a hobby is not pursued for profit. But that doesn’t stop some taxpayers from trying to write off expenses for their dog showing, comic book trading or other “business.”
13. Failure to report a foreign bank account can lead to serious penalties.
Ensure that if you’ve got any such accounts, you report them properly, meaning electronically filing FinCEN Form 114 to report foreign accounts that total over $10,000 at any time within the previous year. And people with several financial assets overseas might also have to attach IRS Form 8938 to their timely filed tax returns.
14. You own a business
The IRS usually looks very closely at taxpayers that are reporting businesses on Schedule C forms since there is lots of room for fudging.
“The IRS mainly targets small businesses, as well as sole proprietorships, and especially cash industries like coin-operated Laundromats and pizza parlors with chances to skim profits and hide income,” said Certified Tax Coaches’ Molina.
If have your own business, report all of the income you have been receiving. If you are still concerned about being audited, you might even want to rearrange your business as a corporation or partnership (which means you’re not required to file a Schedule C) instead of a sole proprietorship, said Molina.
And if you’re flagged for an audit, the IRS will be skeptical of any business that looks like it’s actually a hobby, especially if you are deducting a loss on your return.
15. Claiming business use of a vehicle.
Like your home office, claiming business use of a vehicle is a treasure trove for the IRS when audit hunting. That doesn’t mean you shouldn’t claim your vehicle if your use of it is valid, but be very wary in particular of claiming 100 percent business use. Very few people can successfully claim complete business use of a car they own or lease, so keep good and thorough logs of how you employ your car.
16. Participating in aggressive or high risk tax strategies:
The CRA has devoted audit resources to reassessing and detecting a number of issues, including: tax-free savings accounts, RRSP appropriations, interest deductibility, permanent establishment/residency issues, section 85 rollover transactions, withholding tax, donation arrangements, offshore investment accounts, surplus stripping, loss trading transactions, and artificial capital losses.
What to Do If You’ve Been Audited
What should you do if you are audited? Be honest with the auditor and respond to all inquiries as quickly as possible. Don’t be afraid to show all of your documentation. If possible, hire a qualified accountant and/or represent you.
In the unfortunate case that you’ve been audited, there are several steps to take. First, respond to your letter promptly. “You can ask for more time to gather the paperwork and forms.
Most of the time, the IRS is simply asking for a piece of documentation. But, in some cases, you might consider representation:
If you can’t find the information they’re looking for, you’ll probably want to call a professional to advise you on your next move. And if you’ve been called in to meet with an agent, you should almost certainly bring in outside help ‘Don’t start from the position that everything can be bargained down, noting that if you’re found to have underreported your income, there’s not much room for negotiation. Still, ‘once the audit is done, it can always be appealed, so they’ll cut you a deal that will make you happy because they don’t want it to drag on.'”The IRS also provides information on audits, and you can fill out Form 911
Audits have and will remain a part of the tax collection process for a long time to come, but that doesn’t mean that you have to be among the “lucky” few to be chosen. The key to avoiding an audit is to be honest, document your deductions, donations and income. (To find out more about the auditing process and how to come out on top, read Surviving The IRS Audit.)
Defense Tax has got you covered
When you file a tax return, you automatically receive access to our Support Center, which can help you respond to the most commonly received audit inquiries. The Defense Tax also provides free audit guidance from a trained tax attorney, CPA ‘or’ tax professional to help you understand why the IRS contacted you and to answer your audit questions. For those who want even more protection, DefenseTax offers Audit Defense, which provides full representation in the event of an audit, for an additional fee.
Now that your tax return has been filed, you’re probably ready to close the books in 2014. But what are the chances that the IRS might pluck your return from the mountain of paperwork for what one author calls “the ultimate curse of a civilized society — a tax audit”?
This Kiplinger calculator will give you the answer, based on official data from returns examined by the IRS in 2014