The possibility of an IRS audit worries many taxpayers, but if you are aware of what the targets are, you have a better chance of avoiding an IRS examination.
Of course, there’s no way to guarantee that your tax return won’t be examined since the IRS randomly chooses some returns to audit. So you should always keep meticulous records to prove your deductions.
With that in mind, here are 12 audit red flags:
1. Not reporting all income from third-party payers.
The IRS carefully compares the income you report on your tax return to the information it receives from employers, banks and investment firms.
2. Missing deadlines.
The IRS notices — and penalizes — taxpayers who mail their returns even a few days late. Auditors may wonder what other rules were disregarded.
3. Being self-employed.
Self-employed individuals who file Schedule C are more likely to be audited. The IRS is particularly skeptical of businesses that appear to be hobbies rather than legitimate profit-making ventures.
4. Collecting valuable fringe benefits.
Auditors zero in on non-cash fringe benefits given to highly paid employees. These tax-favored perks include deferred compensation, stock options, split-dollar insurance and golden parachutes.
5. Claiming losses from part-time activities the IRS considers a hobby, such as horse breeding or photography.
The IRS often challenges deductions for losses from part-time activities like horse breeding or photography, claiming they are hobbies rather than businesses. However, taxpayers can successfully dispute these claims by maintaining detailed records, adhering to industry standards and demonstrating a profit in at least three out of five years — or two out of seven for some horse businesses.
6. Not reporting stock trades.
It’s important to keep scrupulous records of your investments. The IRS is aware that some taxpayers make numerous trades online and don’t keep track of the transactions as the law requires. (Under a tax law passed in 2008, more investment sale information is being provided to the IRS by brokerage firms.)
7. Dealing in cash.
IRS auditors are skilled at uncovering tax evasion within cash-based businesses and transactions.
8. Setting up an illegal trust.
Uncle Sam has a hit list of fraudulent deals, including “family residence trusts” and some foreign trusts. Don’t believe claims that you can establish a trust that allows you to avoid taxes, yet still own and control the assets.
9. Donating a car to charity and taking a deduction that’s too big.
Donating a car to charity can yield significant tax benefits, but overvaluing the vehicle is a common mistake. Since January 1, 2005, strict regulations have limited deductions for car donations to the amount the charity receives from selling the vehicle, unless it's used extensively for charitable purposes. Previously, donors could deduct the fair market value.
10. Stepping out of bounds.
The IRS uses sophisticated computer programs to compare tax returns with similar income levels. If your deductions are significantly higher than average, you may be flagged for an audit. This doesn't mean you shouldn't claim legitimate deductions; it simply highlights the importance of accurate recordkeeping to support your claims.
11. Deducting prohibited or suspicious items.
You just can’t write off certain expenses, such as funeral costs and country club dues. There are other deductions the IRS is often skeptical about too, like expensive meals and home office write-offs.
12. Being a “tax protestor.”
Individuals who refuse to pay taxes based on the belief that they are unconstitutional are known as "tax protesters." The IRS takes a strict stance against these claims and is likely to audit taxpayers who adopt such positions. These individuals often face significant legal and financial consequences.
While receiving an IRS audit notification can be unsettling, it's important to remember that most audits involve straightforward requests for additional documentation. With proper recordkeeping, many audits can be resolved without significant stress.
To further mitigate tax-related worries, consider partnering with a dedicated accounting professional.
A BELAY Accounting Professional can provide expert guidance, handle complex calculations and ensure your financial records are meticulously organized. This proactive approach can significantly reduce the likelihood of audit-related issues and offer peace of mind year-round.
Remember, tax laws are subject to change, so staying informed is crucial. Consulting with a tax professional regularly can help you navigate the complexities of the tax code and avoid potential pitfalls.
Ultimately, understanding common audit triggers and maintaining thorough records are essential steps in protecting yourself from IRS scrutiny.