The possibility of an IRS audit can be a nerve-wracking prospect. While most taxpayers sail through tax season unscathed, a small percentage are flagged for closer scrutiny. This article delves into 12 common reasons you might face an audit, helping you understand what to avoid and how to file confidently.
Making Math Errors
Even a single math error on your tax return can raise a red flag for the IRS. Always double-check your calculations, whether doing your taxes or using tax software. A simple error like writing a ‘1’ instead of ‘7’ can trigger an audit. If you are not confident in your math skills, seek professional assistance.
Failing to Report All Income
Not reporting all your income is a surefire way to attract an IRS audit. The IRS receives copies of your income forms like W-2s, K-1s, and 1099s, which are cross-checked against the income reported on tax returns. Any discrepancy between these forms and your reported income gets flagged. This means you must report all sources of revenue, even if you don’t receive a specific form for it, like side hustles or online sales. Remember, the IRS computers are efficient at cross-checking; a mismatch can lead to a hefty bill.
Earning More
While the chance of an audit is generally low, your odds increase significantly as your income increases. The IRS is focusing more on auditing high-income earners and complex business structures. While treasury officials promise not to increase audit rates for those under $400,000, high-net-worth individuals and businesses can expect more scrutiny from the IRS’s specialized audit teams. The IRS’s specialized high-wealth exam squad reviews personal returns and those of controlled entities.
Claiming Large Charitable Donations
While charitable donations are great, claiming an unusually high amount compared to your income can lead to an audit. The tax agency knows the average donation levels for different income groups. To avoid scrutiny, ensure you obtain appraisals for valuable property donations and file IRS Form 8283 for non-cash donations exceeding $500. If you’ve donated conservation easements or are involved in partnerships, LLCs, or trusts making such donations, your audit risk increases.
Excessive Business Losses
Self-employed individuals who claim excessive losses on Schedule C are at the risk of an IRS audit. The IRS expects a balance between business income and expenses. Consistent heavy losses raise suspicion of potential income hiding through disguised personal expenses, triggering closer scrutiny. Ensure that your deductions align with legitimate business costs to avoid unnecessary scrutiny.
Using Round Numbers
Avoid using round numbers excessively on your tax return. The numbers on your 1040 form and other tax documents are usually not in round numbers. The IRS expects calculations to be precise, not rounded to the nearest hundred dollars. Claiming a $900 expense instead of the actual $895.50 can raise suspicion and attract an IRS audit. Be accurate in your calculations to avoid unnecessary scrutiny.
Not Reporting Gambling Wins And Claiming Big Losses
Gambling winnings are taxable income. Recreational gamblers should include winnings as other income on the 1040 form, and professional gamblers show them on Schedule C. Failing to report them can attract IRS attention, regardless of whether you receive a W-2G form. While you can deduct gambling losses, it’s only allowed up to the amount you win and requires itemization. Significant losses, especially compared to reported wins, raise red flags for the IRS, suggesting potential unreported income.
Bitcoin and NFT Transactions
The IRS actively tracks Bitcoin, NFTs, and other digital asset transactions. You must report any buying, selling, or trading on your tax return. The IRS sends letters to suspected virtual currency holders and dedicates specialized teams to audit them. All individual filers must disclose digital asset activities on page 1 of their Form 1040. Remember, crypto gains and losses are taxable, and failing to report them can lead to an audit.
Cash-Heavy Businesses
Businesses that primarily deal in cash, such as restaurants and barber shops, are more susceptible to audits because the IRS scrutinizes them for potential income underreporting. If your business frequently handles large cash transactions, detailed documentation is crucial. You should also include tips in your tax returns. Transactions that exceed $10,000 need to be reported to the IRS with details about the source of the funds.
Claiming Foreign Earned Income Exclusion
US citizens working overseas can exclude up to $120,000 of income earned abroad on their tax return if they meet specific criteria. These include bonafide residents of another country for the entire year or spending at least 330 complete days outside the US. Additionally, having a tax home in a foreign country is essential. Claiming the Foreign Earned Income Exclusion (FEIE) can trigger an audit if the IRS suspects misuse. They scrutinize individuals with weak ties to their claimed foreign country of residence, those who maintain a US abode, certain government employees, and frequent travelers like flight attendants who might not meet the physical presence requirement.
Home Office Deductions
Be cautious when claiming a home office deduction, as the IRS closely examines claims that don’t strictly adhere to the regulations. The IRS defines the home office deduction as applicable to those who use part of their home exclusively and regularly for their trade or business. To qualify, your home office must be dedicated solely to work-related activities. Occasional email-checking in front of the TV won’t suffice. For a more defensible deduction, set aside a specific area in your home strictly for business purposes.
Writing Off a Hobby Loss
The IRS takes a dim view of hobbies disguised as businesses, especially those reporting consistent losses. You’re a prime audit target if your “business” shows no profit in most years, operates like a hobby, and exists alongside significant income from other sources. The IRS closely examines such cases, requiring proof that your activity is genuinely a business venture with a profit motive.