March 8, 2013 : JoeTaxpayer - Guest Contributor
The Top 10 Tax Audit Triggers
Ed Note: As you may know, a tax audit is an IRS inspection of an individual’s or entity’s books and records. If you’re audited, the IRS will send you a letter stating which type of tax audit applies to you. You’ll need to comply with the IRS’ requests for information (which is why you’re advised to keep your tax returns and supporting documentation for 7 years). In his latest guest post, JoeTaxpayer lists some of the top audit triggers; items that may cause the IRS to examine certain returns more closely. Do any of these appear on your tax return?
1. High Income
In this case, it’s simply a matter of “follow the money.” Assuming any individual is as honest as the next, the IRS is likely to have a higher payoff by auditing returns of higher income people. While the overall audit rate is just over 1% of returns filed, a tax return showing over $200,000 of income has nearly a 4% chance of getting audited.
The limit to what you can deduct in charitable contributions is fairly high, as cash deductions to qualifying charities can offset up to half your taxable income. To take charitable deductions, you must have documentation in hand before you file. Contributions of over $250 must be documented by a receipt with specific details spelled out (amount of the donation, value, even if zero, of any goods or services given in return) and in hand before the return is filed, whether it be the normal date or with extension. If you have your supporting documents, don’t fear being a philanthropist.
3. Certain Activities
A number of professions are looked at a bit more closely by the IRS, perhaps because they combine high income potential with an easy ability to accept cash. These include doctors, attorneys, auto dealers, cab & limo operators, and gas retail store owners. For all these professions, it’s a matter of keeping good records to show you’re not hiding income.
4. Failing to Report Income
If you are a W2 employee or receive income on 1099s as a contractor, the IRS gets notified of this income as well. When these documents arrive in the mail, there’s no excuse for misplacing them, as the IRS has this data as well. If your reported income adds up to less than what the IRS shows you earned, an audit may follow. You may not receive a 1099 if the amount earned is under $600, so your total earnings may be higher than the IRS sees. But that’s OK, you need to report it anyway.
The IRS regulations require “that a home office must be used regularly and exclusively for business and the limit tied to the income derived from the particular business.” The current Form 8829 is a 43-line exercise of one’s math skills and patience. For many people, the lack of a separate exclusive area disqualifies their home office deduction.
6. Real Estate Rental Losses
If you are a real estate professional, you may use losses from your real estate to offset other income. The IRS offers a narrow definition of “professional” – it applies only if more than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated, and if you performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated. If you don’t qualify as a pro, your losses may only be limited to offset any income from the properties but no more. In this case the loss may be carried forward until used or until the property is sold to someone not related to you. Claiming a loss when you are not a pro is a red flag to the IRS.
7. Schedule C Losses
If you are starting a small business, you might have some losses along the way, and that’s understandable. Unfortunately, the IRS expects that you’ll be reporting a profit in three of five years. If not, the IRS may believe your business is actually a hobby you are trying to write off as a business.
If you have any winnings from gambling, whether it’s from betting at a horse track, hitting it big at the slots, or those scratch-off tickets at the local newsstand, Uncle Sam is your partner and that income must be reported. Just like a loss in the stock market can offset gains, if you carefully track your losses and keep your receipts, you can use those losses to offset your jackpot money, see Topic 419 from the IRS for more information. If you have no winnings, however, you can’t write off any losses. Claim a net gambling loss for the year, and it’s a potential audit for you.
9. Adoption Tax Credit
This credit is available when you adopt a child into your family, and it’s significant, up to $12,650 for those who qualified in 2012. My friend and fellow blogger Lynnette Khalfani-Cox uncovered a report to Congress showing that 69% of returns that claim this credit are audited. If you adopted a child last year or plan to this year, check out Form 8839 and be sure to have all required documentation on file. Don’t let the threat of an audit let you walk away from a nice tax refund.
10. Missing or Frivolous information
Signature(s), date, Social Security number(s), filing status. These are items that, if missing, will result in the IRS sending the return back to you, and potentially resulting in an audit. There are times for levity, but there’s no place for humor on your tax return. Even if you’ve paid your tax bill in full, if the return itself doesn’t offer enough information or has writing on it that’s not needed, your return may be deemed ‘frivolous’ and can result in a $5,000 penalty.
Unfortunately, the exact numbers that might trip an audit are a secret the IRS keeps to itself. It’s safe to say that, while there’s nothing you can do to avoid being audited, good record keeping, honest income reporting, and reliable tax software like H&R Block’s will go a long way toward keeping the audit process as painless as possible.
If you’ve received an audit notice and want advice or help from others who have been in your shoes, join us in The H&R Block Community.