Two words that strike anxiety into even the most honest taxpayer? Tax audit. In reality, the odds of being audited by the IRS are slim. While the IRS is diligent about collecting the revenues which it is owed, the old days of the IRS driving honest taxpayers and their families to financial ruin are largely a thing of the past.
Related article: 5 Steps to Surviving an IRS Audit
Nonetheless, many taxpayers wish to eliminate even the remote chance that they will face an IRS audit. While there is no absolute guarantee that you will avoid an audit, steering clear of these dozen common IRS audit triggers will place the odds firmly in your favor.
Too Much Income
Just like old time bank robbers, the IRS is more likely to target high-income taxpayers because they are more likely to have financial resources that can be collected. But this doesn’t mean that you should make less money to avoid an audit. It does mean that if you are a high net worth individual, you should be extra diligent about record keeping.
Too Little Income
Low-wage workers are necessarily targets for tax audits by the IRS. But taxpayers who report incomes far below what others in their profession earn might raise flags. For instance, physicians who report less than high five-figure incomes may raise suspicion, unless they work in areas of extreme poverty.
This is a no-brainer. The IRS receives notification of income for wage earners from Form W-2. Non-wage income is reported on form 1099. It really isn’t very smart to underreport your income. Of course, if you have legitimate deductions and tax credits that reduce your adjusted gross income, that’s fine. Just be prepared to verify the tax breaks that you claim in case the IRS inquires.
Did you really make exactly $50,000 last year? If so, be ready to prove it to the IRS. Otherwise, don’t round or average numbers, because doing so sends a signal to the IRS that the rest of your return might be less than accurate.
Discrepancies between State and Federal Returns
Get this one wrong and you may wind up with double trouble: inquiries from Uncle Sam and from your state. Plain and simple, the income that you report to the IRS must match the income that you report to the state. Of course, deductions can and often do differ between the federal government and the state, so differences there are fine.
Unexplained Variations in Income
Your income jumps after you graduate from college and get a great job. Or you lose your job and spend a year searching for a new job. Those kinds of variations don’t generally raise red flags with the IRS. Likewise, self-employed workers need not lie awake nights worrying that their fluctuating income might trigger an audit. But regular wage workers who stay on the job with a single employer tend to have fairly steady wages. Reporting otherwise without supporting documentation may well trigger an audit.
Related article: 10 Tax Preparation Tips For The Self Employed
Unusually Large Losses
If your house burned down last year, by all means, claim the full amount of your losses. Likewise, if your retirement fund was severely affected by a dip in the stock market or by other factors, go ahead and report the decline. But have documentation ready to back up your claim.
Charitable deductions that are out of proportion with your income are a red flag for the IRS. Likewise, self-employed workers who earn much more from their clients or customers than they report in income on Schedule C should brace themselves. If you really are giving away a large proportion of your net worth, keep meticulous records of your gifts and their net worth. Entrepreneurs who record large capital investments in a single year should maintain invoices and other documentation to explain where so much of their income went.
Home Office Deductions
Beginning with the 2013 tax year, the IRS has instituted a much simpler means of claiming the home office deduction. What has not happened is a reduction in the requirement that a home office must be a separate area of your home that’s only devoted to business. A legitimate home office may be a small as a converted closet, but your bedroom or den is unlikely to qualify unless there is an office space used for business only. (IRS.gov)
Sloppy or Incomplete Returns
The IRS makes it really easy to e-file your income tax returns, and for the majority of taxpayers, e-filing is free. You should take advantage of this convenience. E-filing features double-checking capabilities that minimize common mistakes. Placing entries on the wrong line or skipping important entries altogether is rare when e-filed. You also receive a timely alert when the IRS accepts your return, and receive any refunds that you are due in days or weeks, rather than months.
Adoption Tax Credit
The IRS provides a generous credit for adoption. For 2013 the credit is up to $12,970 per child, for up to 3 children. But according to an October 2011 report issued by the US Government Accountability Office, an astonishing 68 percent of the 200,000 federal returns claiming the Adoption Tax Credit that year were flagged for a correspondence audit. But the news was not totally grim. USA Today reported that the vast majority of those audits resulted in no additional tax liabilities.
Straight Up Tax Scams
You should not refrain from claiming any of the tax credits or deductions listed above out of fear of being audited. There is no reason not to claim every tax break to which you are legitimately entitled. But frivolous claims such as paying income tax is voluntary or that federal income taxes are unconstitutional are a fast track to an IRS audit. Likewise, unscrupulous tax preparers that jack up your refund with questionable tax credits and deductions should raise major red flags for you, not to mention the IRS.
Learn more about IRS Audits on our FAQ page.