Tax Related

These 10 Red Flags Could Lead to an IRS audit

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The IRS audited close to a million tax returns in calendar year 2017. This was about .5% of the total returns filed. While this is a pretty small number of audits, being audited is no small matter for those who are subject to an IRS examination.

If the very prospect of being audited fills you with dread, it’s helpful to know some of the most common reasons audits happen.

This list of 10 red flags will hopefully help you reduce the chances of an audit — or at least be more prepared if an IRS examiner comes calling.

According to the IRS, audits usually occur because of computer screening, random selection, or because they’re conducting a related examination, such as reviewing the returns of your business partners.

Here are some of the most common reasons you might end up being audited:

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1. Making errors on your tax return

Sometimes, a simple math error is enough to trigger an audit. If the information you submit to the IRS doesn’t add up, IRS computer screening is very likely to catch the error automatically.

This could lead to a simple audit where you’re asked about the discrepancy by mail and can simply correct it. Or, it could prompt the IRS to take a closer look at your entire return with a more in-depth audit.

To avoid this mistake, always double-check your math — or use an online tax filing program that will catch at least some mistakes for you.

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2. Taking too many deductions

Falsely padding deductions has made the IRS list of common tax scams, and the agency has warned taxpayers against inflating their deductions to reduce taxes owed.

The IRS establishes “norms” based on sample returns. If you take so many deductions you fall outside of the norm, this is a major red flag that could come to the attention of the IRS via a computer screening.

Of course, if deductions are legitimate and you can back them up with documentation, you should claim them. But just be aware that if your deductions are very high as a percentage of income, the IRS is likely going to want to know why.

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3. Being self-employed

When you have an employer, it’s pretty hard to cheat on your taxes because your employer reports your income and you likely have limited deductions for business.

If you’re self-employed, though, you may have income from lots of different sources — including cash income. And you have plenty of chances to deduct business expenses, not all of which the IRS will necessarily view as legitimate.

Since it’s easier to hide money that isn’t reported on a W-2 or to reduce your income with fake business expenses, the IRS is more likely to ask questions of sole proprietors and small business owners.

The IRS may also want to confirm you’ve paid taxes as you earned income, so make sure you submit quarterly estimated tax payments to avoid late payment penalties if you have non-wage income.

You can’t do much to reduce the added risk that comes from self-employment. But you should be careful to keep detailed business records so you can show that you claimed all your income and took only legitimate deductions in case an IRS auditor comes calling.

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4. Earning a lot of money

Millionaires, and especially those making more than $10 million per year, are audited at higher rates than their counterparts who earn far less. This makes a lot of sense, as this is where the money is.

Auditing someone with a small income is likely to result in a low payoff for the IRS, even if it’s determined that taxes were underpaid. But if someone has millions or billions, there’s a far greater chance that underpayments — if they exist — will involve substantial sums.

Earning a lot of income isn’t a problem you want to correct. But, you do need to make sure you’re claiming all the funds you make and that you follow the rules for deductions and credits you claim.

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5. Depositing (or spending) a lot of cash

You’re supposed to report all the income you receive from all our sources. When you deposit or spend a lot of cash, the IRS is going to want to know where the money came from — especially if it’s not clear on your tax returns.

Since your bank is required to report deposits over $10,000 to the government, depositing a large sum at once is especially likely to trigger an inquiry from the IRS. They’ll likely wonder where these funds came from and whether they were declared.

If you make large deposits or spend big sums, be sure to document where the cash came from — and declare all of it so you can pay the taxes you owe on it.

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6. Claiming the earned income tax credit

The earned income tax credit is supposed to help working families with limited incomes by giving them back a refund of some of the taxes they paid during the year. The EITC, as it’s called, is a costly anti-poverty program for the government, with a price tag in the billions.

Unfortunately, requirements to qualify for this credit are very stringent, and the IRS is likely going to want to make very sure that you’re entitled to it if you claim it. EITC recipients are actually more likely to be audited now than the wealthy, according to a ProPublica report. There are many reasons for this, including the fact that Congress has pressured the IRS to prevent overpayments of the credit.

You can’t do much about the increased audit risk and you should definitely claim the credit if you’re entitled to it. But be prepared for your refund to be held up for additional examination, and be sure you’re following IRS guidelines. Don’t claim the EITC if you aren’t actually eligible for it.

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7. Misreporting your earnings on your tax return

You aren’t the only one who reports information on your earnings — your employer does too. If the income you report doesn’t match what your employer says you earned, it’s easy for the IRS to catch the discrepancy. And the IRS is likely to want to know why the numbers don’t add up.

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Double-check your earnings with your W-2 to avoid this mistake — and be sure to report any earnings you have from outside of your job, such as money from a side gig.

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8. Making large donations to charity

Generosity is a good thing, and you are rewarded on your taxes for it since you can deduct charitable contributions if you itemize on your tax returns.

But you are limited in the amount you can deduct for donations. And if you donate a percentage of your income that seems unreasonably large, the IRS is probably going to want to take a close look at whether you really made the donations you’ve claimed.

The IRS may be even more suspicious if you claim a large deduction for non-cash donations, such as donating old furniture or clothing to Goodwill.

Be sure you have documentation of all donations you make and avoid inflating the value of the property you donate to make sure you don’t get into trouble with the IRS.

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9. Claiming the wrong filing status

When you file your taxes, you have the option to claim a standard deduction instead of itemizing. The standard deduction is a set amount, which is based on your filing status. Singles have a smaller standard deduction than heads of household, qualifying widows, or married couples filing joint returns.

You have to choose the correct filing status so your standard deduction can be accurately calculated. Your filing status can also determine your tax bracket as well as whether you make too much money to be eligible for certain deductions.

It’s important you actually qualify for the filing status you claim. If you choose a filing status you don’t meet the requirements for, the IRS is likely to notice, ask questions, and require correction.

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10. Dipping into your retirement fund

When you take money out of your retirement fund, you could be subject to a penalty if you aren’t at least 59 ½ or you don’t qualify for a hardship exemption or special withdrawal.

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And regardless of your age, you’re generally taxed at your ordinary income tax rate on the money you take out of most retirement accounts.

Because many people don’t properly report withdrawals from their retirement accounts, your return is more likely to catch the eye of the IRS when you’ve dipped into tax-advantaged retirement accounts.

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The bottom line on tax audits

Being audited may seem scary, but the reality is that many audits are conducted solely by mail and audits can sometimes result in a larger refund. If you follow the rules, pay your taxes on time, and keep careful documentation of your income and deductions, an audit hopefully won’t be a problem for you.

Related: 8 things you should never deduct from your taxes

This article originally appeared on FinanceBuzz.com and was syndicated by MediaFeed.org.




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