Ever wonder how likely you are to get picked for an IRS audit? How can you avoid it?
Avoiding common IRS red flags, like large unexplained deductions or mismatched income reporting, can significantly reduce your chances of an audit. Good bookkeeping is essential.
Read on to learn more about how to keep your tax return squeaky clean by avoiding these nine IRS red flags.
1. Unreported Income
Unreported income is one of the major IRS red flags because they receive copies of all the W-2s and 1099s filed under your Social Security number. These forms report the income you received from employers, banks, and other institutions. Any mismatch between what you report and what the IRS has on file can trigger an audit. If you get a 1099 with incorrect or someone else’s income, contact the IRS to straighten things out and avoid any confusion.
2. Large Deductions
While claiming legitimate deductions lowers your tax burden, very large deductions compared to your income can raise a red flag for the IRS. They analyze your return and compare your itemized deductions to average deductions for taxpayers in your income range. This doesn’t necessarily mean claiming high deductions will trigger an audit, but significant deviation from the norm can prompt the IRS to take a closer look.
3. Self-Employment
The IRS pays extra attention to tax returns from self-employed individuals for a couple of reasons. Unlike W-2 employees whose income is reported by their employers, the IRS relies solely on the self-employed to accurately report their income and expenses. To validate this information, the IRS gathers data from various sources like bank deposits, credit card receipts, and business expense records. Since income and expenses are self-reported, the potential for discrepancies is higher, making self-employed individuals more likely to be selected for an audit.
4. Home Office Deductions
Home office deductions can be a red flag for the IRS because they involve blurring the lines between personal and business expenses. The IRS scrutinizes these deductions to ensure the space is truly a dedicated and regular workplace, and that the claimed percentage of home use is accurate. To avoid an audit trigger, you should only claim a home office deduction if you meet the IRS qualifications and meticulously document the square footage, percentage of business use, and all related expenses.
5. Round Numbers
Round numbers on your tax return can raise an eyebrow with the IRS because they suggest a lack of detailed recordkeeping. The IRS suspects that numbers like “$5,000 in charitable donations” or “10,000 miles driven for business” may be estimates instead of precise figures based on receipts or mileage logs. It’s perfectly acceptable to round to the nearest dollar for most things, but large, round numbers for deductions, income, or expenses can trigger the IRS to request documentation to verify your claims.
6. Frequent Errors
Frequent errors on your tax return, including both math mistakes and simply leaving entire sections blank, can be a red flag for the IRS. These errors raise concerns about the accuracy and completeness of your filing. Math mistakes, even seemingly small ones, can throw off your tax liability and suggest carelessness. Similarly, empty fields can signal missing information that could affect your tax burden. This doesn’t necessarily guarantee an audit, but it can prompt the IRS to take a closer look and potentially request additional documentation to ensure everything is accurate.
7. Cryptocurrency
Cryptocurrency transactions are a growing area of scrutiny for the IRS because they can be used to hide income. Unlike traditional bank accounts, cryptocurrency transactions can be anonymous, making it tempting for some to underreport or even completely avoid reporting income earned through crypto sales or mining. To ensure proper taxation, the IRS requires any income generated through cryptocurrency activities, like buying, selling, or mining, to be reported as capital gains or losses on your tax return. By keeping clear records of your cryptocurrency transactions and reporting them accurately, you can avoid raising red flags and minimize the risk of an audit.
8. Foreign Accounts or Assets
Foreign accounts and assets can be a red flag for the IRS because they can be used to hide income and assets. Unlike domestic accounts, foreign accounts aren’t automatically reported to the IRS. However, the IRS has a network of international information exchange agreements and can obtain information about your foreign holdings through various channels. To avoid triggering an audit, U.S. citizens and residents with financial interests exceeding a certain threshold are required to report their foreign accounts and assets using two forms: the FBAR (Report of Foreign Bank and Financial Accounts) and Form 8938 (Statement of Specified Foreign Financial Assets). By properly reporting your foreign accounts and assets, you can demonstrate transparency and reduce the risk of an IRS audit.
9. High Income
Statistics show taxpayers with an income of $500,000 or more are now significantly more likely to be audited compared to lower-income earners. The IRS believes that with more complex financial holdings and tax strategies, there’s a higher potential for mistakes or even intentional underreporting at the higher income brackets. Additionally, the IRS is intentionally aiming to close the inequity gap for unpaid taxes by placing a stronger focus on auditing high-income earners to ensure they are paying their fair share.
Final Words
While a tax audit can be stressful, understanding the IRS red flags that trigger them can help you avoid unnecessary scrutiny. By keeping accurate records, reporting all income, and claiming deductions legitimately, you can significantly reduce your chances of being selected for an audit. Remember, the IRS is looking for accuracy and transparency. If you have any questions or concerns, consult with a tax professional to ensure you are filing correctly and minimize your risk of an audit.
