We all have nightmares of opening the front door to find an IRS agent ready to audit our tax returns. But rest assured, only about 1% of all tax returns filed by individuals are audited. And the simpler the return, the less likely you will be audited.
The bad news is that your audit odds go up as your income increases or the more complex your tax return becomes. The Taxpayer Advocate says that the rates for “unreal audits” are as high as 7.4%. An “unreal audit” is simply a correspondence audit from the IRS in which it informs you of a mismatch between the numbers indicated on your tax return and a third-party document.
For example, if your Form W2 showed wages of $62,840 and you reported $62,000, the IRS will send you a letter and a tax bill for the difference. It will also allow you to protest the findings.
When it comes to getting selected for an audit, there are ways to stay under the radar. Dave Du Val, a consumer advocate from Taxaudit.com, specializes in educating taxpayers on how to file taxes to avoid an audit. “Just one item can cause an audit and the top-secret matrix system the IRS uses may kick out a return for an audit based on a number of entries that are just a ‘little off’ from what the IRS matrix thinks it should be.”
Listed below are red flags, according to Du Val, that can that can trigger an audit:
Credits. Taking the Earned Income Credit, Adoption Credit, and the American Opportunity credit can send up a red flag because there are so many qualifications behind these credits.
This does not mean you shouldn’t take every credit to which you are entitled, just be careful when filling out the paperwork and double-check your forms before submitting them. Just because you take advantage of these credits does not automatically place you on the most-wanted list.
Deductions. High deductions for charitable contributions, employee business expenses, and vehicle expenses, can make the IRS suspicious, says Du Val. If these are completely legitimate expenses, then you have nothing to fear, just keep adequate documentation.
I once represented a sales rep in audit that spent almost half of her income trying to drum up new business. She wrote off a large amount of automobile expense, client gifts, and meals and found herself being audited. However, because she kept receipts and a mileage log, and subsequent tax years showed an increase to income which further substantiated her spending, the IRS determined the expenses were valid and it was a no-change audit.
National Standards and Lifestyle. Deductions that are out of proportion with the income you’ve declared can lead the IRS to suspect unreported income. If your address is Bel-Air and you deduct DMV fees of $3,000, property taxes of $15,000 but are showing only $27,000 in income, the IRS is going to wonder how you manage and call for an examination.
Self-employment. Low or no income and high expenses for self-employment can also raise eyebrows. Showing losses year after year will cause the IRS to think that perhaps you are attempting to write off your hobby, so be sure to keep adequate documentation to support your deductions.
Accuracy is important. Be sure to review every number on your tax return before signing and filing it. Du Val says “Take time to learn the rules for the deductions you are claiming and that you qualify for them.”
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, Calif., and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Her new e-book Taxpertise for the Creative Mind Murder, Mayem, Romance, Comedy and Tax Tips for Artists of all Kinds is available at all major booksellers. Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.