Few things spark more fear in someone’s financial life than the idea of a tax audit by the Internal Revenue Service (IRS). But how likely is it that you’ll actually be audited?
According to the IRS, audit rates increase as income increases. For example, approximately 8% of returns in the income category of $10,000,000 and above were audited which is significantly more than the 0.53% of returns that were audited in the income category of those who made between $50,000 or under $75,000.
That said, you shouldn’t take this as a green light to cheat on your taxes! It’s always best to play it straight and safe.
These Red Flags Will Still Attract Increased IRS Audit Attention
How far back can the IRS audit you? As a general rule, the IRS can go back three years for an audit. However, if there’s a major error on your returns, the agency may opt to go back another few years — but typically no more than the last six years.
Anytime you’re facing the prospect of an audit, the key to remember is you need to have solid documentation to back up any claims you make about your overall financial picture — particularly your deductions!
Kiplinger’s Personal Finance magazine has put together a list of things that will could you flagged by the IRS this tax season.
1. Claiming a Home Office Deduction
You need to have a dedicated space in your home that is only used for business to take advantage of this deduction. Doing so lets you prorate some household expenses such as utility bills, homeowner’s association fees and more on a fractional basis.
When you claim this deduction, you have to figure out exactly how much square footage is dedicated to your business in your home versus how much square footage you have in your home at large. Of course, this area is also ripe for abuse! You’ll need to be able to prove the area you’re claiming is separate and exclusive for business use.
2. Giving a Lot of Money to Charity
The IRS knows what others who make a similar income to you tend to give, and they will question you if you’re claiming too much.
Again, the key is to have accurate and complete documentation to prove you’ve made the donation and to prove the value of the donation if it’s non-monetary.
In general, one of the least scrutinized ways to make a donation is with good old-fashioned pen and paper. As USA TODAY notes, “Gifts by check are hard to falsify.”
How will you be notified of an IRS audit? Should you be audited, the IRS will only contact you by one method — U.S. Postal Service mail. If you get a phone call about being audited, hang up. It’s almost certainly a scam!
3. Deducting Unreimbursed Business Expenses
Unreimbursed business expenses are only deductible beyond 2% of your adjusted gross income, and most workers already get reimbursed by their employers for such out-of-pocket expenses.
But if you don’t get that reimbursement, things like dues, license fees, subscriptions to trade journals, tools and supplies and specialty uniforms are all legitimately deductible.
The gray area here is when you get into deductions for non-allowables like commuting costs and everyday work clothes. Again, the IRS knows what is outside normal bounds based on your income and will question you if you’re too far out of the norm.
4. Using Digital Currencies
The government is looking for people who fail to report income from cryptocurrenices for an IRS audit, according to CNBC.
In the most extreme situations, failing to report crypto income can result in fines of up to $250,000 and prison time.
5. Not Reporting Taxable Income
You must report all 1099s and W-2s, even if you believe them to be incorrect. (Just don’t forget to deal with the discrepancies after filing.)
Remember, the IRS gets copies of all the 1099s and W-2s you receive. So don’t think they don’t know!
6. Claiming Day-Trading Losses on Schedule C
What’s the difference between an investor and a day trader? An investor is someone who buys long-term investments and holds them for a minimum of five to 10 years. A day trader is someone who cycles in and out of investments regularly based on short-term price fluctuations.
The IRS knows a lot of people who try to pass themselves off as day traders by claiming losses on a Schedule C are really just investors trying their hand at something new. So they’ll be on the lookout to start an IRS audit if you fall into that bucket.
That’s yet another reason to follow money expert Clark Howard’s advice about investing for the long haul — not for short-term gain! Check out Team Clark’s simple investment guide here.
7. Deducting Business Meals, Travel and Entertainment
The new tax law did away with the deduction for entertainment expenses. What’s left is meal deductions and travel.
To qualify for the meal deduction, keep detailed records of the following:
- The amount spent
- The place of the meeting
- A list of people attending
- The business purpose of the meeting
Meanwhile, when it comes to travel and lodging, you want to keep receipts for expenditures that are $75 or more when you’re on the road away from home on business.
8. Claiming Rental Losses
Being a landlord is tough, but it’s definitely one route to building long-term wealth. Becoming a landlord starts with finding the right tenant. That way you’re less likely to incur rental losses in the first place!
9. Claiming 100% Business Use of a Vehicle
Be careful, salespeople! To counter any possible IRS questions, consider keeping a paper log on the dashboard and writing down every mile for work, the date and what it was for. If you do want to claim all the costs for a business expense, be sure you have another vehicle too.
10. Hiring a Preparer Who Falsifies Your Return — Without Your Knowledge
Incompetent or unethical tax preparers can cost you big time. Should the IRS see a pattern of problems on returns coming from one preparer, they may flag the entire operation’s returns for that year or the past several years.
If an egregious error is discovered, it’s likely to be on you — not the tax preparer.
How long does an IRS audit take? Factors such as the type of audit; the complexity of the issues; the availability of info requested; scheduling of required meetings; and your agreement or disagreement with the outcome can all affect audit length.
11. Writing Off a Loss for a Hobby
Businesses are meant to be profitable. If you report losses for at least three of the past five years, your “business” is more likely to be viewed as a hobby by the IRS. And you’ll be in hot water because the IRS disallows any business deductions for hobbies that you may try to claim on your Schedule C.
12. Filing a Form 5213
This one’s likely to attract IRS audit attention as time goes on, though not necessarily right away.
Form 5213 basically tells the IRS not to audit you for the first five years of your business. The most common scenario where it’s used is when someone is trying to transition their hobby into a legitimate business.
But once that five-year window is up, the spotlight is going to be on you with renewed intensity.
13. Committing Basic Math Errors on Your Return
Maybe you weren’t great at math in school. Nobody’s here to judge you! But the reality is that basic math errors in adding and subtracting will raise suspicions about what else could be wrong with your return.
The solution is simple: Use tax software and leave the math up to machine intelligence. The IRS Free File program offers free tax prep for people with incomes below $72,000.
14. Taking an Alimony Deduction
The new tax law changes the way alimony is treated. Alimony paid under divorce agreements after 2018 is no longer deductible, nor will ex-spouses get taxed on alimony received under post-2018 divorce agreements.
But one thing remains the same as before: You’re still likely to attract IRS audit attention if there is a mismatch in reporting by the payer and the recipient of alimony on each of their tax returns.
15. Running a Business Where Almost All Money Is in Cash
The IRS has its sights set on cash-heavy businesses like taxis, car washes, bars, hair salons, restaurants and so on. Also likely to face additional scrutiny are people participating in the “gig” economy, such as driving for Uber or Lyft in your spare time.
Meanwhile, pass-through businesses like S corporations, partnerships and limited liability companies could be in the agency’s crosshairs, too.
16. Not Reporting a Foreign Bank Account
Watch out if you’ve got money stashed in an off-shore account. An IRS audit could be headed your way!
To ward off any unwanted audit attention, be sure you’ve electronically reported any foreign accounts that combined were in excess of $10,000+ at any time during the previous year. You can electronically file FinCEN Report 114 (FBAR) by April 15 for this purpose.
You may also need to attach IRS Form 8938 to your tax return if you have substantially more than $10,000 in a foreign bank account.
17. Engaging in Currency Transactions
The main purpose of currency trading is to allow businesses that operate in multiple countries to lower the risk of exchange movement and its effect on their profits. But some people try to do foreign currency trading as a “get rich quick” scheme. That rarely ends well.
If you are doing currency transactions, just know that the IRS gets reports of cash transactions above $10,000 from banks, casinos, car dealers and other businesses. So if you’re heavily into this sort of thing, don’t attempt to skirt currency transaction rules or you may just get an IRS audit notification in the mail!