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The IRS “Dirty Dozen”

If only about 1% of all individual returns filed are selected for audit, what is the cause for those returns that are selected?  Although the only taxpayers that should be worried about an audit are the ones cheating, here are 12 examples that might draw IRS attention to your return:

1. Failure to report all taxable income- the IRS receives copies of all 1099’s and W-2’s you receive. If the income reported to the IRS doesn’t match what is reported on your return you may receive a bill or your return might be flagged for audit.

2. Claiming the home-buyer credit- claiming the home-buyer credit requires proper documentation to make sure only those for whom the credit was intended will receive it. If proper documentation is not provided the return may be flagged. Also those that took the home-buyer credit and sell the home in the recapture period should be aware that the IRS checks public real estate databases for sales of homes for which the credit was taken.

3. Claiming large charitable deductions- if your deductions are disproportionately large compared to your income a red flag may be raised. Also donations of valuable property without an appraisal or if you fail to file Form 8283 for donations over $500, the chances of an audit increase. Make sure to keep all receipts and documents from your donations.

4. Home office deduction- because of the strict rules governing the home office deduction many who make a claim do not qualify, so the IRS looks closely at those returns.

5. Business meals, travel, and entertainment- large deductions for these types of expenses are always closely monitored especially if the amount seems too large for the business. To qualify for meals, travel or entertainment deductions, you must keep detailed records and receipts documenting business purpose.

6.  Claiming 100% business use of vehicle- cases of a vehicle being used 100% for business especially when no other vehicle is available for personal use is extremely rare. Because of the rarity, the IRS closely scrutinizes this deduction.

7. Claiming a loss for a hobby activity- hobby loss is nondeductible to the extent of hobby profit but many taxpayers get around this by filing a Schedule C with the loss. If your “business” activity sounds like a hobby and you claim losses in at least 3 out of 5 years you might be asking for an audit.

8. Cash businesses- cash business like bars, restaurants, or taxi drivers are easy targets for auditors. Because of the nature of cash business it is fairly easy to fail to report all taxable income. IRS audit agents have new guides to interview the owners and noting various indicators or unreported income.

9. Failure to report a foreign bank account- the IRS is very interested in people with offshore accounts. Failure to report a foreign bank account can lead to severe penalties. Recently the IRS had had success in discovering these bank accounts by offering a compliance program offering lesser penalties for those that came forward.

10. Engaging in currency transactions- the IRS receives many reports of cash transactions over $10,000 involving banks, casinos, car dealerships, and other businesses. Also banks report to the IRS instances of suspicious activity. A taxpayer that frequently makes large cash transactions should be aware of IRS scrutiny.

11. Math errors- one of the biggest reasons to receive a correction letter from the IRS is because of mathematical errors. If an error is made in the taxpayer’s favor there is a greater probability of the entire return being flagged.

12. Taking higher-than-average deductions- if your deductions are disproportionately large compared to your income your return could be flagged for audit.

A taxpayer has no obligation to pay more tax than is actually owed, therefore if you qualify for deductions don’t be afraid to take them but make sure you have proper substantiation to back them up.

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