We’ll begin by imparting an inconvenient truth: Even if you dodge all the tax audit red flags detailed in this guide, the IRS still may audit you.
That’s because the IRS selects approximately 50,000 random tax returns each year to flesh out its annual audit. With nearly 200 million people filing their taxes every year, this amounts to a minuscule percentage of random audits indeed. But, just how tiny do we mean? We’re talking about only .025% of all filers.
If you avoid any funny business, then your audit risk is roughly the same odds of being born with an extra finger or toe. Sure, it can still happen, but it doesn’t occur all that often. However, what happens if you get a little too creative on your tax returns? Your risk of being audited jumps up nearly ten times.
Needless to say, none of us is above making an honest mistake. But, if you avoid the common reporting pitfalls laid out in this guide, you can significantly decrease your chances of suffering an audit. (And, we definitely meant to use the word suffering as a descriptor here.)
Have you already received an audit request from the IRS? Then, read no further. Time is of the essence when it comes to getting your ducks in a row and avoiding a more serious set of consequences. Contact our award-winning tax audit experts at Steven Lissner & Company today and receive best-in-class audit protection. With a certified public accountant in your corner, you’ll be able to minimize your losses and ensure a clean bill of financial health.
Without further ado, our experts reveal their top 8 red flags to avoid if you don’t wish to trigger an IRS audit.
1. Failure to report all of your taxable income.
This tax-filing no-no may sound like a no-brainer. Unfortunately, however, this reporting mistake is easier to make than you may think—especially if you work as a freelancer or subcontractor.
Often, gig workers receive a 1099 form from their clients for services rendered. This non-descript form usually appears in your mailbox, crammed between stacks of junk correspondences and sales circulars.
However, a 1099 form holds the same weight as a W-2 with the IRS. Specifically, the values from your W-2s and 1099s go directly into a database that the IRS checks alongside your tax returns. Failure to report any income results in an automatic mismatch in the system, often triggering an official audit.
What’s the moral of the story here? Always go through your mail with a fine-tooth comb and never dispose of a 1099 form. The funds therein may seem paltry, but every penny adds up in the eyes of the IRS.
2. Fudging the numbers on your business expenses.
If you’re the proud owner of a small business, then you’ve probably heard that the IRS offers generous tax deductions to self-employed entrepreneurs. While this is true, some business entrepreneurs stretch the boundaries of what the law allows when it comes to claiming deductions.
Consider the much-loved (and hated) home office tax deduction. You can deduct expenses (e.g., utilities, a portion of your mortgage, etc.) associated with operating a home office if and only if the space meets specific requirements:
- The space is dedicated solely and regularly to your business activities. Unfortunately, this requirement means that you can’t devote the room to, say, 60% home office and 40% fitness studio use—unless, that is, you run a fitness studio.
- The home office that you’re deducting serves as your principal place of business. If you spend the majority of your time conferring with clients at a brick-and-mortar location outside of your home, then your “home office” doesn’t make the cut.
Here’s where tax filers fall into a potential sandpit. They either claim a home office that doesn’t count as such or claim “business expenses” that fall into the personal expense category. Always be mindful of the costs you claim, handing off the tricky calculations to a certified public accountant. If you attempt to outfox the IRS, it usually catches up with you.
3. Fibbing about your charitable donations.
Here’s where the IRS is a little crafty. Their experts have aggregated the data from decades and decades of tax returns. This attention-to-detail means that the IRS can now predict the value of your annual charitable donations based on your income bracket.
This fact doesn’t mean that you shouldn’t donate—and donate BIG—to your favorite charities. But, it does mean that you definitely shouldn’t fib about the amounts and always keep a detailed record of your contributions. You should be able to furnish receipts for any donations for at least five years.
4. Hiding funds in an offshore banking account.
This audit trigger is a screaming red flag for illegal activity—especially tax evasion. In the olden days, overseas banks didn’t have to report your holdings to the United States. Instead, you simply had to admit on your taxes that you owned foreign assets. These days, however, the regulations stipulate that these institutions must report any foreign investments made by American citizens to the IRS. As for your personal responsibility to the IRS, you must report any funds in these accounts that exceed $50,000 and divulge the specific entity holding the assets.
Needless to say, if you can avoid opening an overseas account, you should do so at all costs. Merely claiming to have an offshore account can trigger an audit. But, not doing so can result in jail time.
5. Inaccurately claiming rental losses.
If your Adjusted Gross Income (AGI) is less than $150,000, then you can deduct up to $25,000 in rental losses from your income. Furthermore, you can deduct unlimited rental losses if you work as a real estate professional who fulfills the following criteria:
- You devote more than 50% of your annual work hours to activities involving real estate development, brokerage, or serving as a landlord.
- The time spent engaging in these real estate activities also equals more than 750 hours each year.
These deductions can confer HUGE benefits on those who engage in real estate activities, safeguarding their livelihood from unscrupulous renters. But, the IRS knows that any significant tax break will also attract individuals who may try to game the system.
Like claiming charitable contributions, you should still take this deduction if it applies to your situation. But mind your p’s and q’s as this deduction tends to fire up the audit machine.
6. Double-dipping when claiming education credits.
If you attend an institution of higher learning, you may be eligible to claim the American Opportunity Tax Credit (AOTC) for the first four years of your education. But, don’t think you can get away with claiming the AOTC for a fifth year. The IRS monitors this credit exceptionally closely to ensure that taxpayers aren’t cheating the system.
Similarly, students who have completed more than four years of postsecondary education can leverage the Lifetime Learning Credit (LLC). Unlike the AOTC, the LLC exists to provide much-needed financial assistance to lifelong learners.
However, there’s an additional caveat to taking either of these credits. In a given year, you can’t claim more than one of these education tax credits. This is because simultaneously claiming both of these credits amounts to double-dipping when deducting your expenses, and it will result in the IRS flagging your tax return for closer inspection.
7. Deducting your expenses using only round numbers.
This red flag may sound a little bit silly to you. Who cares if you claim deductions totaling $1,000 vs. $1,000.18 on your tax returns?
Unfortunately, the IRS expects you to track your expenses down to the penny with supporting documentation (like receipts) to prove your claim. If you take a series of deductions amounting to $1,000, $500, and $725, the IRS assumes that you didn’t bother to do your math. This approach poses a significant challenge for the IRS as those flawed guestimations can add up to LARGE deductions.
Here’s the bottom line: Ditch those round numbers and hold on to those crumpled-up receipts. Think of filing your taxes as analogous to preparing for court. If you want to win your case, it pays to have hard evidence in your back pocket.
8. Botching the math.
Even a math whiz occasionally punches a wrong value into their calculator while daydreaming about… anything other than filing their taxes. As the proverb goes, “To err is human.” If only the IRS were so forgiving.
Simple math errors are among the most common reasons that the IRS issues an audit or initiates a collections strategy. You may think that automated tax services deliver an error-proof solution to committing math blunders. But, think again. Software programs are as imperfect as their creators.
Given these challenges, what’s the best way forward? The answer is more straightforward than you may think. It involves harnessing the best of both worlds.
Enlisting the expertise of a certified public accountant can help you avoid costly mistakes and defang the consequences of an audit. Certified public accounts use software programs to file your tax returns, but their meticulous attention to detail provides an added layer of protection to the process. Think of your CPA as the safety valve that prevents your tax return from completely melting down.
Help! I’ve been audited by the IRS.
If you’ve been audited by the IRS, then don’t panic. With over 30 years of tax filing experience, Steven Lissner & Co. delivers the superior intervention you need to overcome a tax audit. Mounting an adequate defense ensures that you’ll minimize your invoice and possibly avoid legal consequences for honest errors. With a tax representative in your corner, your interactions with the IRS will seem like a piece of cake.
For tax audit protection that you can trust, contact Steven Lissner & Company today!