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Audit Triggers

Around 1% of individual tax returns are audited annually.  If you have prepared you return truthfully, there is no reason to fear an audit.  Even in cases of math errors, or a mistake, most people will not be subject to a full blown audit.  Most returns that are audited contain one of the following triggers:

  1. High income – Taxpayers with income over $200,000 or higher are more likely to be audited. With 1 out of 9 audited for taxpayers that report one million or more.
  2. Failing to report income – The IRS computers are pretty proficient at matches W-2's and 1099's to your individual return.  Make sure you save these forms and give them to your tax preparer.  If you receive one in error, contact the issuer immediately.
  3. Large charitable deductions – if you claim charitable deductions that are out of proportion of your income you could be audited. The IRS compares these deductions with the average of those at the same income level.  Also failing to file the correct forms for non-cash charity over $500 or when an appraisal is necessary can make you a target. Solution: document well and save your documentation.
  4. Day traders – If you claim day-trading losses on Schedule C you may be subject to an audit just because of the sheer complexity of the rules.
  5. Rental losses – especially when the taxpayer claims to be a real estate professional; are more likely to be audited, again because of the specificity of the rules.
  6. Schedule C filers – Statistics have shown that the most underreporting of income and overstating expenses is done by the self-employed.  Because of this the IRS looks closely at Schedule C filers, especially at meals & entertainment and travel expenses.  Record keeping and documentation are essential in this area.
  7. 100% business use of a vehicle – keep a detailed calendar and mileage log to prevent the IRS from disallowing or reducing your deduction.  Also if you claim a mileage rate you may not also claim actual expenses for a vehicle.
  8. Writing of losses for a hobby activity – hobby expenses are only allowed up to hobby income.  Only business losses are allowed to offset other income.  If you have questions on whether your activity is a business or hobby see our article titled Hobbies & Taxes. (link to article)
  9. Claiming the home office deduction – a home office can only be deducted if it is used regularly and exclusively for business. It may not double as a playroom, guest room, etc.  The IRS may check out your claim so make sure you can prove the exclusivity of your space.
  10. Alimony Deduction – to qualify for this deduction the payments are subject to specific rules.  For instance the payments must be made pursuant to a divorce or separation agreement and must end on the occurrence of the former spouse’s death. Many divorce decrees do not specify the payments appropriately and thus the IRS makes them a target.
  11. Cash based businesses – if the nature of your business is cash based such as a bar or salon you could be targeted for audit.  Cash based businesses have statistically been likely to inaccurately report income and therefore the IRS likes to keep a close watch on them.
  12. Failing to report a foreign bank account – if you have a foreign bank account that totaled more than $10,000 USD in a year, you are required to report and file specific forms to the IRS.  From the amnesty programs the IRS has used the last few years, they have been gathering information and targeting certain foreign banks to get information on US account holders.  Make sure you are in compliance with your reporting requirements.
  13. Large currency transactions – the IRS gets reports from banks, car dealers, casinos etc of large currency transactions over $10,000.  Banks also tend to report suspicious activity that seems to try to escape notice by making many deposits just under the $10,000 threshold.  If your reported income seems inconsistent with these large deposits you may be in store for an audit.
  14. Higher-than-average deductions – the IRS publishes average itemized deductions for taxpayers in certain brackets.  If your deductions seem out of proportion to your income, you may be scrutinized.  To see how you compare to the 2012 preliminary data see our article Comparing your itemized deductions.

 

Remember you are only obligated to pay the tax you legally owe, you should not fail to take deductions that you are truly due because you fear an audit.  Documentation is vital and if you have questions consult a tax preparer.

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