Discrepancies in a taxpayer’s returns may prompt the IRS to investigate them. An audit refers to the process of evaluating an individual or company’s financial details to verify that they comply with tax laws.
Receiving an audit notice doesn’t automatically mean you’re guilty of tax crimes. In most cases, the IRS is just double-checking numbers looking for discrepancies. There’s nothing innately sinister about an audit, and as long as you tell the truth, the whole truth, and nothing but the truth, you have no cause for concern.
Why the IRS Performs Audits
The IRS may audit random accounts as a way of improving tax compliance. These evaluations ultimately reduce the tax gap, which is the difference between what is owed and what they receive. Other times, it could be due to suspicious activity. To avoid unwanted attention or scrutiny, here are 13 flags to check, so you don’t end up in the IRS hot seat.
1. Math Errors
The IRS will hit you with fines whether you mistakenly or deliberately enter the wrong figures in your tax returns. These errors include adding or emitting zeros. Avoid this situation by carefully scrutinizing your returns before submitting or getting help from a qualified tax preparer. You can also invest in tax preparation software to avoid common math errors.
2. Wrong Filing Status
The federal tax agency offers various deductions, credits, and exemptions depending on personal and professional circumstances. Married couples enjoy certain advantages over single taxpayers, as do widows. To avoid an IRS audit, you must file under the status that best describes your situation. If multiple options apply to you, the system picks the one with the lowest possible tax amount.
3. Partially Reported Income
Failure to report some of your income is a surefire way to invite an IRS audit. If you’re employed but have some freelance jobs on the side, you must report all your earnings. Fill Form W-2 for your salary and Form 1099 for your freelancing activities. The IRS expects entities that employ you as an independent contractor to report payments through Form 1099-MISC. Failure to report your earnings will prompt the agency to audit your account.
4. Too Many Charitable Donations
Although you deserve deductions for charitable donations, too many claims will raise eyebrows. Other than avoiding false claims, ensure you have accurate documentation to verify legitimate philanthropic activities.
5. Deducting Excess Business Expenses
Some individuals and businesses report too many expenses as a way of reducing their tax obligations. Your business purchases must conform to your particular trade. Don’t claim deductions for hobbies and other unrelated activities.
6. Home Office Deductions
Avoid claiming deductions for unnecessary expenses if you work from home. Because the IRS collects taxes from millions of other home-based workers, they have accurate data on the average claims. Their system will pick out your account for auditing if you report figures that don’t follow these expectations.
7. Schedule C Losses
If you’re self-employed, resist the urge to report personal expenses under business costs. You must be able to prove that your fuel, research, and other credits directly benefit your business. If your company keeps reporting losses, the IRS might launch an audit to determine how it stays afloat.
8. Numbers That Are Too Precise
The figures on your Form 1040 and associated documents will raise suspicion if they are round and neat numbers. If they keep ending with zeros, it might look like you’re making them up. The solution is to round off to the nearest dollar if you must. For example, if you claim a business expense for an item you bought at $197.75, you can round it off to $198 instead of $200.
Self-employment doesn’t have the proper structures associated with established corporations. As such, the IRS treats these operations with more suspicion due to the higher likelihood of false documentation. You’re also more likely to undergo an audit if you file a Schedule C.
10. Non-Existent Dependents
The IRS recognizes only one parent per dependent. The agency might launch an investigation if more than one person claims a deduction for the same dependent. For your claim to be eligible, you must provide birth certificates, medical records, and other documentation as proof.
11. Foreign Bank Accounts
You stand a higher chance of undergoing an audit if you’re an American citizen who lives abroad. Due to the complicated filing process, expatriates might deliberately or accidentally omit some information. The best option is to consult a tax expert conversant with tax clauses that address these complications.
12. Cash Transactions
The IRS isn’t a big fan of cash transactions because they’re difficult to track. If you make many of them, the tax agency may assume you engage in illegal activities or don’t report all of your earnings. The IRS also gets alerts about suspicious cash transactions from financial organizations.
13. Failure to Report Capital Gains
If you profit from any sale of stocks or other assets, the IRS expects you to report it in your tax returns. Your brokerage will provide a tax form detailing your gains or losses, but you’re still supposed to add them to your return. Be sure to report profits on securities via Schedule D on your return. If you file your taxes earlier than your broker, you must amend your returns to report capital gains.
If you are selected for an audit, don’t panic. Collect and organize your documents and reach out to a professional. Working with an experienced CPA or EA can help you make wise decisions and bring you peace of mind.
Have you ever experienced an audit? If you have any tips or suggestions, feel free to share them in the comments below.