Despite less than 1% of federal individual tax returns being subjected to audit each year, there are certain tax reporting situations that may increase one’s chance of an IRS inquiry. Outlined in this article are several of the most common triggers to be aware of. Your accountant or tax attorney can help you navigate these potential red flags, keeping you off the IRS’s radar.
Income-Related Triggers
Underreporting Income
Failure to report all income can quickly lead to an inquiry. The IRS receives a copy of all W2’s, 1099’s and other reports that document your income. Any discrepancy between your tax return and these documents can raise a red flag.
Mismatch of Income Reports
Differences between what you report on your tax return and what your employers or clients report will almost certainly cause you to receive an IRS notice. Check your tax return for any inconsistencies and ensure accuracy on all documents.
Failing to report Gambling winnings
Casinos and other venues use form W-2G to report any gambling winnings that are deemed as taxable. These winnings should be reported as either other income or on a schedule C. Failure to do so can result in an IRS inquiry.
Not Reporting Foreign Accounts
Failing to disclose foreign bank accounts when required can result an IRS examination, as well as significant civil and criminal penalties. Taxpayers with offshore accounts or assets must file the required forms. The IRS and FinCEN have strict reporting requirements for these foreign assets and accounts.
High Income
Taxpayers with a higher income are more likely to be audited by the IRS due to the complexity of their financial situations. As a result, the probability of discrepancies and errors is higher. Even minor errors can lead to the IRS taking a closer look at your overall tax return.
Deduction & Expense-Related Triggers
Excessive Deductions
Claiming unusually high deductions that do not align with your income level can put you on the IRS radar. Consider keeping detailed records and receipts to substantiate any deduction you are reporting.
Claiming a Loss on Your Business
Taxpayers who claim yearly losses from their business activities may draw scrutiny from the IRS if the losses persist. The risk of doing so can prompt the IRS to examine the ‘for-profit’ motive of your business and whether it is actually a hobby, in which case deductible losses may be disallowed.
High Expenses Relative to Income
Claiming business expenses that are disproportionate to your reported income could be a red flag for the IRS. Taxpayers are advised to maintain proper records and documentation to prove that the intent of their business is indeed to make a profit.
Rental Property Deduction
Rental properties can offer substantial tax deductions to qualifying taxpayers. However, failing to report all rental income or incorrectly calculating or claiming excessive deductions can increase your risk of being audited.
Self-Employment Income
Taxpayers who are self-employed can face an increased possibility of being audited due to underreporting income and/or claiming excessive deductions on their taxes. Keeping current and detailed records of all transactions in accordance with accounting standards can help to protect against this.
Home Office Deductions
One of the primary criteria for claiming the home office deduction requires that the space is used exclusively and regularly for business purposes. Taxpayers should adhere to this rule and be sure they qualify for the deduction to begin with.
Filing & Reporting Triggers
Filing Late or Not at All
Failing to file or consistently filing your tax return late can attract scrutiny from the IRS. If you are unable to file by the April 15th deadline, be sure to send in an extension application (Form 4868) and pre-pay any taxes you plan to owe.
Large Charitable Contributions
Reporting large donations does not create an audit risk in and of itself, however without appropriate documentation it would be difficult to defend yourself should the IRS decide to take a closer look.
Cash Transactions
Individuals engaging in frequent cash transactions, particularly over $10,000, could be subjected to higher levels of scrutiny. Taxpayers are advised to maintain records of both source and use as they pertain to any material cash transactions.
Claiming Tax Credits Improperly
Taxpayers claiming tax credits on their tax returns should exercise diligence in making sure the proper credits are being claimed, assuming they qualify in the first place. Tax credits work to reduce your tax liability dollar for dollar and, therefore are subject to increased scrutiny from the IRS.
Avoiding these common tax reporting mistakes can reduce the likelihood of an IRS audit. Always consult a tax professional for guidance tailored to your specific financial situation. Proper documentation and accurate reporting are key to staying compliant and off the IRS radar.
Written By: Kerian Stewart
