What are the Top 10 Audit Flags?
Only 1.0% of the population will be subjected to an IRS audit (7.0% if your income is over $1 million) but the thought of being the one in every hundred that is “selected” is enough to encourage us all to do whatever we can to avoid it. There’s no question that the IRS is “kinder and gentler” than in years past but there’s still a significant amount of personal intrusion and disruption that occurs in an audit, not to mention the expense.
Here are the top 10 things taxpayers do/don’t do that can result in an audit:
1. Incorrect Social Security Number – Believe it or not, this is the most common reason for an IRS inquiry. Make sure you type it right and recheck once your return is done.
2. Incorrect Math – Another simple one, and often just an honest mistake but it opens the door for the IRS to look deeper and raise other questions. This alone may be worth using a tax preparer. If you choose to do it yourself, use a software program that has the math build in.
3. Whistle blowing friends – The IRS pays up to a 30% bounty to anyone who turns in someone who’s misrepresented their taxes. And most of the time, the whistle blower is a friend or relative who the taxpayer bragged to about what they did. Whether or not it was legal, bragging about how you slid one by the IRS is never a good idea.
4. Failure to File – This is a surefire way to raise the IRS inquisition team – a substantial amount of financial information is reported to the IRS about you each year so don’t assume they won’t know. Plan on filing every year unless a tax professional tells you it’s not necessary.
5. Schedule C Business Income & Expense – This schedule, listing your self-employment income and expense, has long been considered a suspect form by the IRS. Far better to incorporate your business activities and report them under a separate tax return. In addition, doing so will expand the allowable deductions and substantially reduce the audit risk.
6. Home Office Deduction – Another longstanding suspect entry to be avoided if at all possible. While recent changes in IRS requirements will make it simpler to report, it’s still considered a questionable entry. Put the expenses on the separate return (see #5 above) to avoid issues.
7. Schedule E – Rental income and expense – Yet another suspect form because of the number of entries the IRS can’t directly verify. Report the income and expenses in a separate entity and the chance of questions goes way down.
8. Charitable Contributions – Whether it’s cash or goods, if you make a substantial contribution, make sure you have good records. If it’s goods you’ve given, be conservative in the value you place on them.
9. Foreign Assets – The IRS is cracking down on the use of foreign jurisdictions used by taxpayers to hide assets. While most don’t have intentions of using foreign investments this way, if you have foreign assets, count on the IRS asking questions. Consider holding your foreign assets in a separate entity.
10. Prior Audits – If you’ve been subject to an audit, be careful for the next 2-3 years. Don’t take risks or be overly aggressive in your reporting.
And a final word of advice if you are ever audited – get a professional involved at the very beginning of the process. Doing so will cost you their fees but it will save you substantially in both time and money. Most audits handled by professionals are successfully resolved. Most handled by the taxpayer themselves are usually resolved in favor of the IRS. Highlighting the fact that an audit is as much the approach to the IRS as it is having good records.