The IRS can audit a taxpayer if there is an error or red flag on their tax return. Examples could include inconsistencies, large deductions or claims, or unreported income. Getting audited doesn't necessarily mean you've done anything wrong, but it's still a stressful and time-consuming process. In fact, the IRS recently secured $80 billion in funding to bolster its tax enforcement efforts, so it's more important than ever to ensure your tax return is accurate and complete.
The IRS also recently introduced a new commissioner, Daniel Werfel. When he was appointed, he asserted that the IRS will not use their new funding to execute more audits for households earning under $400,000 a year. Regardless, it's important to know the triggers that cause IRS audits to not get caught in avoidable errors.
Red flags that trigger IRS tax audits
Here are the top ten reasons taxpayers come under audit by the IRS, according to the experts.
1. Underreporting or not reporting your income
When filing your tax return, remember that the IRS receives all of your W-2s and 1099s from your employers. Make sure the income you report on your return matches the income your employers say you've earned. If there is a discrepancy on your W-2, immediately report it to your employer. The IRS uses sophisticated software programs that automatically issues a red flag if it looks like you haven't reported your income accurately.
2. Having improper deductions
Large deductions that seem out of line for your profession or business can be a red flag for the IRS. For example, if you run a small flower shop and made deductions of lavish travel, entertainment and meal expenses, that could trigger an audit to inspect these deductions.
3. Depositing a lot of cash
If you make a cash deposit to your bank over $10,000, your bank will automatically be notified. If you run a cash-heavy business that requires you to make such deposits regularly, ensure you have the proper invoices and documentation to back up your cash. Read more: Understanding Cash Deposit Limits in Banks.
4. False charitable donations
Giving from the heart is an honorable thing to do, but claiming large donations to charities just to get tax credits is a big no-no. If you do indeed give charity throughout the year, ensure you get documentation, and fill out Form 8283 for any charitable donation over $500.
5. Leaving too much up to estimation
Rounding up or down is tempting when estimating things like business expenses, but, when filing tax returns, it's best to be as precise as possible. IRS flags are set off by round numbers like $200 or $50. Ensure you're reporting as clearly as possible and have all proper documentation and receipts.
6. Home office deductions
Since the COVID-19 pandemic, many people have switched to working primarily from home. However, keep in mind that home office deductions are primarily available only to people who are independent contractors, not to full-time employees. A tax professional can walk you through the specifics of which home office expenses can be deducted, and what cannot.
7. Having a high net worth
If your household makes over $10 million a year, your chances of being audited by the IRS are quite high, close to 1 in 10. In contrast, if your household makes less than $100,000, your risk of getting audited is minor, at less than 2 households out of 1,000 getting audited, according to the Government Accountability Office.
8. Forgetting about payment platforms
Starting next year, the IRS will required third-party payments platforms like Venmo and Cash App to report payments for services and goods of $600 or more per year. If you're a freelancer and receive payment for your services through these apps, don't forget to account for them on your tax return.
9. Showing a pattern of losses for your small business
If you own a business, the IRS wants to see that it is legitimate and makes a profit. If you have a business "on paper" without generating profit just for the purpose of writing off deductions, that will set off alarm bells with the IRS.
10. Having foreign accounts and assets
The IRS has a focus on taxpayers who have large amounts of cash and assets like real estate overseas. The IRS has treaties with many countries which require foreign banks to provide the IRS with a list of their American account holders. If you have accounts and assets overseas, it's best to consult with a professional tax advisor who can inform you of which forms you have to fill.
To reduce the risk of an IRS tax audit, it's important to take certain precautions when filing your tax return. First, report all income accurately, including income from freelance work and investments. Avoid simple math errors and ensure that all the numbers you enter are correct. Keep thorough records of all your receipts, invoices, and other supporting documents to back up your deductions and credits. Be careful not to claim excessive deductions, as this can raise suspicion and potentially trigger an audit. Finally, consider seeking professional advice from a qualified tax preparer or accountant who can help you navigate complex tax rules and identify potential issues that may raise red flags with the IRS. By taking these steps, you can help reduce your chances of an IRS audit and ensure that your tax return is accurate and compliant with tax laws.
Lastly, if you owe back taxes for previous years, working with a reputable tax relief provider can help you negotiate with the IRS to reach a payment plan.