The odds of being on the business end of an IRS tax audit are pretty low. According to its 2019 Data Book, the Internal Revenue Service (IRS) has conducted fewer audits every year over the past decade. In 2019, they only audited 0.4% of taxpayers. However, audits aren’t determined by chance alone. Certain actions are IRS audit red flags, which can raise or reduce your odds of getting audited. So what can you do to prevent an audit? Read on to learn 16 IRS audit red flags, and how to avoid them.
IRS audit red flags
Keep in mind, having IRS audit red flags in your tax return is not necessarily a problem. If you do get audited, all you need is the appropriate paperwork to prove that your claims are legitimate and accurate. That’s why it’s imperative that you keep rigorous files on your income and expenditures every year!
And when you do your taxes this year, keep an eye out for the following:
Failing to report some income you made from a side-gig might sound harmless. But the IRS knows exactly how much you made this year. When you earn income, your employer generates a W-2 (for wage earners) or a 1099 (for non-wage income). And when tax season rolls around, the IRS receives copies of each of those forms. This makes it virtually impossible to get away with underreporting your income.
Of course, legitimate credits and deductions can reduce your adjusted gross income. But if there’s too big a disparity between the figure the IRS receives and one you report, that’s a major red flag.
Too many deductions and credits
If you make 50,000 dollars per year, and your deductions total 45,000 dollars, the IRS may have a few questions. Of course, this doesn’t mean that you shouldn’t claim every penny to which you’re legitimately entitled. What it does mean is that you should maintain meticulous paperwork to back up your claims, because you’ll probably need it.
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Excessively generous charitable contributions
The IRS knows what most households at your income level donate to charities every year. If you claim a lot more than the average as a deduction, you are likely to draw their attention.
Again, if you have the proper paperwork to back up your claims (especially Form 8283 for non-cash deductions valued at more than 500 dollars), there’s no problem. Claim every contribution you’ve made – just make sure that you have receipts!
Claiming rental losses
If you manage rental properties as a landlord, you can deduct up to 25,000 dollars against your income. And real estate professionals (individuals who spend more than half their working hours and at least 750 hours annually acting as developers, brokers or landlords) get even bigger tax breaks. If you’re a real estate pro, you can write off any losses that you incur without limitation.
However, be wary. The IRS examines the returns of taxpayers who claim to be real estate professionals but who also report substantial non-real estate related income. If this applies to you, be ready to prove the legitimacy of all of your income sources.
Claiming a hobby as a business
Do you love taking photos? It’s a wonderful hobby – and an expensive one. But unless you earn a reasonable profit from your picture-taking, you can’t write off your costs as business expenditures. And if you write off costs as business expenditures for a hobby that you’ve never reported a profit on, the IRS may get suspicious.
For the IRS to consider your hobby a legitimate business, you should report a net profit on your activities at least 3 out of every 5 years.
Stashing money overseas
Maintaining offshore bank accounts and financial holdings is not illegal. But maintaining foreign financial reserves for the purpose of evading federal income taxes certainly is. Individuals with foreign tax holdings of more than 10,000 dollars must declare their holdings on FinCEN Form 114 by June 30. Taxpayers with larger financial holdings must attach Form 8938 to their federal income tax returns.
Many institutions that formerly operated as tax havens now share intel with the IRS – including the identities of their U.S. account holders. If you fail to report any overseas holdings, you’re at serious risk of undergoing an audit.
If you have an offshore bank account that you’ve failed to report, the IRS has introduced a voluntary amnesty program that will let you come clean without consequence. Unless you want to be on the receiving end of an audit, be sure to report your holdings before tax season’s out.
Claiming 100% business use of a vehicle
If you run a refuse collection agency, odds are good that your refuse collection trucks are used exclusively for your business. As such, claiming 100% business use for these vehicles is perfectly fine!
If, on the other hand, you use your own personal vehicle to deliver packages, drive Lyft, or deliver food orders, you cannot make such a claim. You can still claim mileage, gas, and other expenses for miles you drove on the job! But be sure to maintain accurate logs if you want to stay in the IRS’ good books.
Inaccurate gambling reporting
You’re a professional gambler and lost big last year. At least your misfortune is a legitimate tax deduction — as long as you maintain sufficient records to back up your claim.
On the other hand, if you score a huge gambling win, the IRS is going to take a cut. Casinos and lotteries report such winnings to the IRS, so if you fail to report this income, you’re well on your way to an audit.
Whether you’re claiming massive losses without evidence, or neglecting to report your winnings, you’re going to get the IRS’ attention. Avoid these IRS audit red flags or face the consequences.
Claiming the home office deduction
You’re self-employed and you’ve set up a dedicated office in your house or apartment where you conduct business. By all means, claim the home office deduction. The IRS even provides a simplified formula of 5 dollars per square foot, with a maximum deduction of 1,500 dollars. Your home office doesn’t even have to be an entire room! Any space that is exclusively devoted to business counts as a legitimate home office deduction.
But the keyword here is “exclusive.” If you work at a desk in your bedroom that doubles as a gaming station, or you set up shop at your kitchen table, you cannot claim this deduction.
For most taxpayers, your odds of being audited are very low. But for taxpayers with very high incomes, those odds go up. Taxpayers with incomes over $200,000 had an audit rate of 0.53% in 2017. Households making more than $1 million had an audit rate of 2.21%. And for households making more than $10 million, that rate is a whopping 6.66%.
If you have a higher-than-average income, be ready to prove your income sources and deductions, because you very well may have to.
Related: Did you know that if you owe back taxes, the IRS can garnish your wages? Find out how you can stop wage garnishment by the IRS.
Filing sloppy tax returns
Computers process most federal income tax returns. But if IRS computers get discombobulated by math errors, the IRS calls in an actual human to sort out the mess. Once that happens, your odds of being audited increase dramatically. To avoid this situation, consider using tax preparation software that checks for math errors and omissions.
Browse tax preparation companies here:
Making significantly less than others in your profession
If you’re a professional and make way less than the average, expect a call from the IRS.
For example, if you’re a physician and you only report an annual income of 10,000 dollars, the IRS is bound to take notice. Of course, there’s no need to inflate your income or pay more taxes than you owe. Just be prepared to explain your low income to the IRS when they call.
Discrepancies between federal and state tax returns
Yes, the federal government and state departments of revenue communicate with one another. If your reported income differs from between your federal and your state income tax return, the IRS will have questions. To avoid this situation, consider using a tax preparation program like Credit Karma or TurboTax. These software solutions will check both your state and federal tax returns for errors.
Yes, rounding your income to the nearest hundred will make the math easier, but it’s not worth it. Too many round numbers raise suspicion that you may be shaving off taxable income. Break out the calculator and include the exact figures when you prepare your return.
Steak dinner with your clients
According to the IRS, you can deduct “non-entertainment related meals” as a business expense. However, they must be directly related to your trade or business, and the IRS must deem them “ordinary and necessary expenses. That means a luxurious night out with your clients probably won’t qualify.
The rules that govern this deduction are strict, so it’s a good idea to read up on them before asking the government to pay for your drinks.
Every year, people deliberately try to cheat on their tax returns. The IRS is hip to a wide variety of fraudulent tax return schemes, so the odds of getting away with tax fraud or tax evasion are not in your favor.
And even if you do escape prosecution for a year, the statute of limitations for tax evasion can extend for decades, depending on how the IRS frames the charges. That’s a long time to have the IRS looking over your shoulder.
If your tax return features any of these IRS audit red flags, don’t panic. As long as you have evidence that your claims are legitimate, you have nothing to fear from an audit. If you’re worried, consider hiring a tax attorney to help advocate for you during an audit. Or use tax preparation software to keep your tax return error-free.
And if you’ve accrued a pile of tax debt, tax fraud is not the answer. Instead, it can help to have a tax relief company on your side. The best tax relief companies have tax lawyers and enrolled agents on staff, provide a money-back guarantee and charge competitive rates. Check out which tax relief company is the best fit for you.
Audrey Henderson is a Chicagoland-based writer and researcher. She holds advanced degrees in sociology and law from Northwestern University. Her writing specialties are sustainable development in the built environment, policy related to arts and popular culture, socially and ecologically responsible travel, civic tech and personal finance.