Tax Audit

The IRS has a computer system called the Discriminant Information Function (DIF) that detects anomalies in all tax returns which may lead to an audit. Watch out for the following things that trigger an audit that may cause you a lot of stress. 

Duplication of information. If you and another person claim the same dependent, the DIF will pick this up.

High income. If you earn over $500,000, your return is scrutinized more, and you may be audited. 

Too many deductions. You are expected to live on your earnings. Therefore, if you wipe out all or most of your income through tax deductions, you are likely to be audited. For example, if you claim a high mortgage interest, and your income does not qualify for such a high mortgage, you will be audited.

Overlooked income. The IRS gets copies of all your employment income, interest income, dividends, tips, income from services rendered, and casino or lotto winnings. If you do not report any income on your tax return, they will pick up the missing income.

High cash deposits or expenditure. If you deposit more than $10,000 in cash or pay more than $10,000 in cash to buy something, the shop or the bank notifies the IRS. Failing to explain how and why you received that cash triggers an audit.

Self-employment. If you are a sole proprietor or freelancer, you are allowed to deduct office expenses, mileage, meals, communication, entertainment and travel. If you deduct more than what is normal for your profession, you will be audited.

Home-based business. The rule is that your home office must be used for business only. If it is used for something else and you claim it as a deduction, you may be audited.

Cash-based business. If you run a salon, bar, barber shop, restaurant, car wash, or taxi service, you are tempted to “forget” to declare it on your tax returns. So, the IRS keeps an eye on your lifestyle to see if it is in line with your reported income.

Income from a hobby. If you have not made a profit from your hobby in at least three of the last five tax years, it is not a business. However, a big hobby like horse breeding may get the IRS interested in you. Keep records to prove that you don’t depend on the so-called hobby for a living.

Offshore assets or cash. If you have assets or cash in another country, particularly one with favorable tax laws, and fail to declare them, you will be audited. The IRS has access to most foreign banks which are obliged to provide lists of American account holders. 

You Claimed the Earned Income Tax Credit (EITC). Claiming the Earned Income Tax Credit automatically triggers an audit. N.B. This is a refund that you claim for your child dependents that increases as the number of child dependents increases. The IRS must make sure that your reported income is accurate and that you are really entitled to claim those dependents. 

Avoid audits

You get audited if a financial situation has placed you in an IRS category that indicates that you may owe more tax than you say you do. Have all your paperwork ready to support your figures.

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