Red Flags that may Trigger an IRS Audit
Thank you to John Siebert from Siebert & Reynolds, CPA's (columbus-cpa.com) for the following information. In case you were unaware, 2013 is over. Hopefully you take the next few months to compile (or have your CPA do it) the information required to minimize your federal tax burden. Every year there seems to be a debate over what deductions to take, and whether taking those deductions will result in an audit of your tax return. First, if you are entitled to take a deduction, I believe that you should take it. Of course, the caveat is you should have the documentation to support that deduction (a step often missed or forgotten by taxpayers). That being said, there are a number of "red flags" that may increase the chances that your tax return will be subjected to an IRS audit.
- Making too much money. Believe it or not, your chances of an audit increase the more money you make. The examination rate for all returns is approximately 1%. However, for those with income in excess of $200,000, that rate increases to 3.7%. Should you make over $1,000,000, the risk of audit jumps to 12.5%. Not a reason to deny a pay or distribution increase, but it is a good idea to make sure your documentation is in order.
- Neglecting to include income on your tax return that was reported on a W-2 or 1099. It should be common sense that if you have income reported on a document that states the information is reported to the IRS (as W-2s and 1099s often do), then you should include that income on your tax return. It is common to see this type of information omitted with respect to 1099s generated from the sale of securities (e.g., from retirement accounts). Even if the result of the sale is a loss, the income from the 1099 still must be reported.
- Large charitable donations. Specifically, if your donations to charity are larger than the average, the IRS may take a look at your return. The average charitable contributions reported for Adjusted Gross Income ("AGI") of $50,000 to $100,000 for 2012 was $2,693.Therefore if you claim charitable contributions in excess of that number, you need the documentation to back it up (for example, receipts from donation centers, statements from Non-profits, etc.).
- Home office deductions. This has been a red flag, not due to the difficulty of the calculations, but rather because the IRS realizes that many taxpayers are poor record-keepers with respect to the use of the home.
- Rental Real Estate losses. If your return includes losses from rental real estate, and you claim to be a real estate professional, be aware that the IRS has stepped up its scrutiny in this area, and there is a risk your losses could be deemed to come from passive activity (less favorable tax treatment).
- Meal and entertainment deductions. Specifically if you are self-employed, it is critical that you keep good records of the business purposes for your meal and entertainment deductions.
- Vehicle usage. Claiming 100% of your vehicle usage can result in an IRS visit to examine your return. Whether you claim 100% of your vehicle or not, it is important to keep a contemporaneous mileage log if you use your vehicle for work. It can be digital or hard-copy, but it should include date, where you went and for what specific purpose (i.e. training, perform service, etc.), and of course the mileage.
- Consistent large losses. If you file a Schedule C that consistently has large losses, the IRS may deem your "business" to actually be a hobby, which results in significantly different (and less favorable) tax treatment. Just another reason why it is important to have a written business plan and separate bank accounts for your business.
- Cash businesses. Bars, restaurants (and their workers) and handymen, I am looking at you (and so is the IRS). Businesses that are primarily cash income businesses continue to be a favorite target for audits.
- Foreign bank accounts. There should be no surprise that foreign bank accounts are of significant interest to the IRS.
- $10,000 transactions. Repeated currency transactions of $10,000 or more suggests to the IRS that there may be unreported income.
- Excessive itemized deductions. Taking itemized deductions that are comparably large to income can trigger an audit. The relevant deduction information from 2012 for a taxpayer with AGI of $50,000 to $100,000 was as follows:
- Medical Expenses: $7,100
- State & Real Estate Taxes: $6,050 (Ohio is generally higher, which is recognized by the IRS)
- Mortgage Interest: $10,600 (again, Ohio is generally higher)
You should not be fearful of an IRS audit SO LONG as you have proper documentation with respect to your deductions. That being said, considering the red flags above is important for any taxpayer. If you have questions, feel free to contact me at Josh@theHElawfirm.com or (614) 759-4603.
