One of the biggest fears everyone faces during tax season is the dreaded audit. Having to deal with an IRS auditor and being asked to provide a plethora of additional documentation to verify the information in your filed return can be time-consuming and costly.
Furthermore, you run the risk of penalties stemming from a tax audit. However, there are some common triggers that the IRS looks out for when determining who to go after. Here are ten of the most common tax audits to be aware of as you begin thinking about next April 15th.
High Income – If you earn over $200,000 a year then congratulations, your chances of receiving an audit have risen dramatically. Once a person crosses the $200,000 mark in yearly income then, unfortunately, they will more likely be targeted for an audit. This fact alone though does not mean that they have done anything wrong.
By just making that much money, the IRS is going to look and see that they are paying enough tax on it. As your income level rises further, so does the agency’s interest. It’s not fair by any means, but it is a reality you should be aware of and prepared for, regardless.
Deductions – The IRS typically tracks the average size of deductions based upon a taxpayer’s income level, such that the more money a person makes, the more deductions expected. However, if a return comes to their attention with deductions that seem far too numerous than the person’s income level, they can use that as a red flag to trigger an audit. The key to making it through an audit on these grounds is documentation.
If, for example, you are making donations and then writing them off then ensure that there is clear documentation to support the write-off. For example, if you are donating something that is non-cash in nature and valued over $500, then you will likely need to fill out a Form 8283, which covers charitable property contributions other than cash itself.
Math Errors – As silly as this may sound, simple errors in math on your tax return alone can trigger an audit. Your return is logged into an IRS computer and if their system registers any math errors upon entry, then the return’s validity will come into question. That’s why it is best to have all the math double checked before submitting your return. It only takes a few minutes and will avoid a lot of further hassle afterward.
Home Office Deduction Claims – One particular deduction claim that the IRS likes looking for is the home office deduction. The reason they enjoy going after this during an audit is that they have shown success in reducing the deduction itself. As a result, if you do choose to claim it on your return if the return also reports a Schedule C loss or shows income from wages, then you will likely be flagged.
Remember that when claiming a home office deduction, said space can only be used exclusively for business purposes. It cannot stand-in as a spare bedroom, child’s playroom or anything else non-connected with your business. Again, careful documentation will be on your side if a tax audit comes up because of this reason.
Entry Errors and Typos – Not unlike math errors, typos and other entry errors on your tax return can trigger a tax audit. If the numbers and information you input on your return do not match up with what the IRS itself has in its files, then they can call you in to ask about it. This cross-referencing is why even if a professional preparer handles your return, it is still your legal obligation to review it before filing. Taking the time to review any potential mathematical or claim errors will save you a lot of headaches later, including a tax audit risk.
Charity Donations – As was touched on above, the IRS looks at your deductions and charitable donations in conjunction with income level. If they notice contributions which seem far out of line with what you earn income-wise, they’re going to come looking around. This fact does not mean that you shouldn’t make any charitable donations ever, but make sure to keep records of everything for accuracy and file the appropriate forms. For anything over $500, make sure to fill out a Form 8283 to cover it, for example.
Owning A Business – The IRS likes going after business owners and entrepreneurs because they know that they claim various deductions, but sometimes may fail to report all of their income. That is why they will always pay extra attention to Schedule C when business owners file it because of the various deductions often claimed for it.
Of particular interest to them are ventures that are heavily cash-based such as bars, car wash establishments, salons, restaurants, etc. The IRS also tends to take an extra look at sole proprietorships and pass-through entities more than regular corporations these days. This does not mean you should not work with those kinds of entities but be aware that it is a potential red flag for a tax audit. As long as you have everything in order paperwork-wise, everything should be ok.
Claiming Business Use For Your Vehicle – Just as they like going after home office deductions, the IRS keeps a lookout for business usage deductions that apply to your vehicle. Don’t be discouraged from claiming this deduction if it’s legitimate. However, be aware that if you try to claim 100% business usage for your vehicle, an audit is almost guaranteed. To avoid any problems, one tip to follow is creating and maintaining detailed logs of your business-related usage and keep them on file.
Claiming A Hobby Loss – Some people will attempt to claim losses on their returns from hobby-related activities. Unfortunately, the IRS does not allow such activity at all because a “hobby” is a pastime that is not meant to be pursued for monetary profit. Attempting to claim a tax break on your memorabilia collecting or amateur sports interests is going to draw attention that you do not want to face.
Incompetent/Unethical Tax Preparer – If you don’t prepare and file your tax returns, then another common cause for audits are returns filed on your behalf by shady preparers. If someone is promising you incredibly high refunds but does not ask for the necessary and proper documentation to claim the deductions they say are possible, then you have a real problem.
Moreover, if an audit does happen, you will be the one having to face it alone. This is why Anderson’s team of CPAs works to make sure our clients provide all necessary documentation before preparing any returns for filing.
Remember that the IRS has no problem looking for reasons to perform a tax audit, especially if you are a business person that is successful at what you do and making money from it. That is why the team at Anderson Business Advisors has spent the past twenty years working with business owners, investors, and entrepreneurs to secure and protect their assets from unnecessary taxation.
Our team of lawyers and CPAs can help you stay compliant with the latest tax laws while making sure you don’t have to pay any more than your fair share. If you’d like to learn more about how we can do that for you, feel free to contact us for a free thirty-minute strategy session.
Toby Mathis, is a founding partner of Anderson Law Group and current manager of Anderson’s Las Vegas office. He has helped Anderson grow its practice from one of business and estate planning to a thriving tax practice and national registered agent service with more than 18,000 clients. In his work as an attorney, he has focused exclusively in areas of small business, taxation, and trusts. In addition, Toby was the past director and host of the longest-running local business radio program on KNUU in Las Vegas “The BOSS Business Brief”. He sits on the board of directors for several companies and was recently appointed to the local board of Entrepreneurs’ Organization, a worldwide association of owners of successful businesses. He has authored more than 100 articles on small business topics and has written several books on good business practices, including first and second editions of Tax-Wise Business Ownership and 12 Steps to Running a Successful Business.