10 Red Flags That May Trigger an IRS Audit

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“I love being audited!”

– No one ever

While it’s impossible to completely eliminate the possibility of being audited, you can at least be aware of what could make the IRS want to take a closer look at your return.

Rare photo of an IRS auditor in uniform

🚩 1. Leaving out an item

Not reporting an item, especially an income item, is a surefire way to be placed under the IRS’s microscope. The institution from which you received the income will not only send a form detailing your income for the year to you, but also to the IRS. The IRS matches all the forms they receive in your name to your return, so be sure to double and triple check all your sources of income for the year.

🚩 2. Home office deduction

Home office deductions are completely legal but are also often abused and, therefore, more heavily scrutinized by the IRS. When defining the area of your home that is used for business, it is important to remember that the area must be used exclusively for business. Making a business phone call in the kitchen before dinner won’t cut it if you’re trying to deduct a portion of your phone bill.

🚩 3. Business use of your car

The same logic for home office deductions applies to deductions related to the business use of your personal vehicle. Taxpayers have been known to take advantage of this deduction in the past. Honesty is the best policy here; oftentimes––as with the home office––the deduction isn’t even worth the risk of possibly being audited.

🚩 4. Higher than average charitable contributions

If you report higher than average donations for the year, relative to your income, the IRS may ask for receipts of your donations as proof. Here is a general idea of the average charitable contributions by income level*:

Adjusted Gross Income (AGI)

Average charitable deduction

% of AGI

Under $25,000 $1,874 12.3%
$25,000-$50,000 $2,594 6.8%
$50,000-$75,000 $2,970 4.8%
$75,000-$100,000 $3,356 3.8%
$100,000-$200,000 $4,130 3%
$200,000-$500,000 $7,424 2.6%
$500,000-$1,000,000 $18,615 2.8%
$1,000,000-$2,000,000 $43,944 3.2%
$2,000,000 or more $382,953 5.6%

*Source: IRS statistics of income 2014

🚩 5. Major changes from last year

Drastic changes from year to year can cause the IRS to raise an eyebrow. If income, deductions, business ventures, major life events, or anything else changes throughout the course of the year, make sure you have receipts, documentation, or any other form of proof in case the IRS comes knocking.

🚩 6. Making too much money

Believe it or not, your chances of being audited increases as you make more money. If you make under $200,000, you have about a 1% chance of being audited. If you make more than $200,000, the percentage increases to 4%. If you make more than $1 million, your chances jump to 12.5%!

Mo’ money, mo’ problems

🚩 7. Reporting large losses

If you are self-employed, have a side business, or have rental activity and report sizeable losses, the IRS could question the validity of the expenses and deductions taken. Make sure you save your receipts, keep adequate records, and maintain good books just in case you are ever asked to substantiate your losses.

🚩 8. Hobby losses

You are allowed to write off expenses related to business expenses, but you cannot write off expenses related to a “hobby”, which is defined by the IRS as something you do for fun without the intention of making a profit. If you show losses for more than two out of the past five years, the IRS can deem your activity as a “hobby” and disallow current and prior years’ losses.

🚩 9. Using round numbers

Using round, even numbers (meaning numbers ending in multiples of 100) could tip off an IRS agent that the expense or deduction may be an estimate or even fraudulent. Avoid rounding; be precise with your expenses and deductions. If your business activity is loaded with expenses of $500, $300, $1,000, $200, etc., it makes it pretty easy to assume that the numbers are estimated and that there could be a lack of supporting documentation.

🚩 10. Failing to report foreign assets and/or activity

Year after year, the IRS foreign reporting requirements are becoming more and more stringent. If you have foreign activity, foreign assets, assets held in a foreign country, etc., it is crucial that you report the activity or disclose the assets on the correct form(s). Failure to do so could result in an audit, not to mention steep penalties.

What To Do Next

Keep track of your activity and holdings throughout the year. Tax planning and regular, transparent communication with your CPA are the best ways to make sure you avoid an audit.

Questions or comments? Let us know! We’d be happy to discuss them with you 🙂

The photo used for the featured image of this blog post is by LucenaMedina (Own work) [CC BY-SA 4.0], via Wikimedia Commons

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Nick Aiola is a CPA and the owner of Aiola CPA, PLLC. Nick and his team provide the highest quality of tax and advisory services to real estate investors and individuals and business owners in the real estate industry.

Phone – (646) 397-9537

Email – nick@aiolacpa.com

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