Have you ever wondered what your chances are of being audited by the IRS? Once you file your taxes, the last thing you want is the IRS knocking at your door. The IRS conducts tax audits to ensure financial information is reported properly according to the tax laws. These audits help reduce the “tax gap” (i.e., the difference between what the IRS is owed and what they actually receive). When selecting which returns to audit, the IRS uses both automated and manual procedures. While some of these audits are random,others are triggered when the IRS identifies certain red flags as described below. You can reduce your exposure to audits by working with a tax professional to eliminate the red flags within your control. However, depending on your situation, some of these red flags are unavoidable.
Not reporting all of your income
All tax documents you receive are also submitted to the IRS. It is important that you report all income from all sources. Failing to report all of your income increases your likelihood of being audited.
A significant increase in income compared to the prior year
Although it may seem unfair, getting a significant raise may prompt an audit.
Too many deductions or credits
Claiming too many credits or deductions as compared to others with similar tax profiles may garner increased IRS scrutiny. These include things like alimony, home, and charitable deductions
Early withdrawals from your 401(k) or IRA
Taking early payouts from your qualified accounts result in taxes and penalties, but it might also trigger an IRS audit.
You are self-employed
Believe it or not, self-employment can be a red flag for the IRS. Your chances of being audited increase when you claim certain costs as a business expense. This includes costs associated with your home office. As long as you keep receipts and show a business purpose for any deductions and credits you take, you shouldn’t have anything to worry about.
Too many business expenses
Although business meals can be legitimate business expenses, frequent or substantial write-offs may get the attention of the IRS.
Reporting large losses
Large losses are often a red flag for the IRS, especially if the losses are from an activity that could be considered a hobby. Generally, in order to deduct a loss, you must be able to prove that you have a legitimate business and that the losses incurred relate to your business.
You were too generous this year
Although donating to charity is an admirable event, the IRS is on the lookout for those who state they donated more than they actually did. The key to donating in any instance is to maintain proper documentation of your gift in case you ever get audited.
Off-shore bank account
The IRS is very interested in people with money outside the United States, so having a bank account in another country is a big red flag for an auditor. Maybe you are traveling more for your career or you have recently retired and are taking those trips you have dreamed about. Regardless of the reason, if you have a foreign bank account, make sure you report it and are ready for a potential audit.
Stifel does not provide tax advice. You should consult with your tax advisor regarding your particular situation.