According to a recent report from Kiplinger, there is only a 1% chance that your tax return will be audited by the Internal Revenue Service (IRS). In many instances, the selection is completely random, but there are common triggers that can draw attention to your tax return.
Typographical errors on the body of your return can cause auditors to raise their eyebrows. Examples include variances between:
- The Social Security Number on the tax return and Form W-2 Wage and Tax statement
- Federal Employer Identification Number the IRS has on file and 1099 statement(s)
- Transposed numbers on the body of the tax return
- Mathematical errors
- Omitted information
Not only will these occurrences lead to an automatic rejection of your return, but there is a slightly elevated change that it will get audited in the near future. To prevent this from happening to you, carefully review Topic 303 prior to submitting your tax return.
If your income has followed a specific pattern for an extended period of time, whether it be on an incline or at a steady pace, a major variance in a particular tax year may leave the IRS wondering if your income is indeed understated. This is especially true for those instances where income drastically declines because of the risk of receiving an inflated refund due to a disproportionate level of tax deductions and credits.
High-value donations commonly attract the attention of the IRS, especially when they are not practical. For example, if you generate yearly earnings that are comparable to that of a middle-class citizen, writing of a large of major assets as charitable contributions may trigger an audit because a donation of this sort is highly unlikely.
There is nothing wrong with being a philanthropist, but always be sure to document any contribution that exceeds $250. It is best to obtain a receipt from the recipient which indicates the name of their entity, amount and contents of the transaction.
To learn more about charitable contributions, review Topic 506.
Because of the high risk of overstated losses against gains, this figure is often an area of focus for IRS auditors. If you decide to claim a gambling loss, closely examine Topic 419 to ensure that you abide by the rules.
Adoption Tax Credit
A news article from Fox Business indicated the significant effect on audit risk as a result of the adoption tax credit. If you plan to take this credit for a qualifying adoption, be sure to review Topic 607 and complete Form 8839 and all corresponding documentation required by the state in which you reside prior to filing.
Since business owners control their inputs and outputs, it is quite simple to "cook the books" by adjusting the earnings and losses on paper. As a result, the audit risk is substantially higher for those that are self-employed. Self-employed individuals who carry a high level of risk include, but are not limited to:
- Auto Dealers
Fortunately, the IRS website contains a number of tax resources to assist those who fall into this category.
Omission of 1099 Forms
If you are performing a service on a contractual basis, you should receive a 1099 form shortly after your tax year ends that discloses the actual earnings received. The payer also provides the IRS with this information so that it will be on file when they write-off the expense. Failing to include earnings generated from the performance of contractual services can trigger an audit as it indicates a case of underreported income.
Real Estate Rental Losses
This is a very common audit flag if the number is excessive. To qualify for inclusion on the tax return, losses must be attributed to 750 hours or more of activity engaged in by real estate professionals during each tax year. For additional guidance on real estate rental losses, see Publication 527.
Large Business Deductions
Certain business expenses call for a write-off, but doing so in an excessive manner can raise a red flag. Specifically, home office, meals and entertainment, automobile, mileage and gift-giving expenses are closely monitored. A comprehensive list of qualifying business deductions along with guidance on each can be found on the IRS website.
Schedule C Losses
Schedule C is the form that enables business owners to report their income and losses. In some industries, slight losses are common and to be expected, specifically within three to five years of initial operations. After that point, the IRS may step in and mandate that activity be classified as a hobby.
Although negative outcomes can cost you a substantial amount of money, rest assured that audits are nothing to worry about if you maintain adequate records and file each year in an accurate and timely manner. Bear in mind that the result can always be contested at any phase of the audit.