If you are afraid of receiving a tax audit, you have every right to be. Tax audits are a big nuisance as well as being time consuming and sometimes expensive. Being aware of the common reasons most people get audited can help you to avoid getting audited or can ensure you will have the proper documentation if it does happen. Most tax audits are brought on by a computer scanning a tax return and the computer triggers a flag or a series of flags that will mark that tax return for further review. No one knows the exact formula the IRS uses in their computer system to trigger audits, which makes sense because then people would figure out ways to cheat on their taxes without the IRS flagging their return. However, there are many known factors that are likely to trigger an audit. Below are the 10 most common IRS flags.
- Charitable contributions & income level: The IRS knows what a typical person at your income level gives for charitable contributions and if the amount given differs from the average by too much, the IRS will likely investigate. If you do give more than the average person then be extra sure to keep all appropriate records. Getting audited for this type of flag is normally a standard correspondence audit that can be cleared up by sending proper documentation to the IRS.
- Not reporting all your income: The IRS has a matching process that matches what you have filed to what other third parties claim to have paid you. Once the IRS sees that things don’t match up this is a major flag and will trigger an audit. IRS computer systems are getting more and more complex and their matching system is becoming more efficient than ever, so failure to report income will not be missed by the IRS.
- Low income for your profession and where you live: The IRS knows what the average income is for the profession you claim. If your tax return shows you made far less than the average person that lives in the same area with the same profession, this will likely flag your tax return. Many professions that receive most of their income through tips often get this flag. The IRS knows many people are tempted to not report all their income because they feel there is no way of them knowing what they actually took in, which is true for the most part, but if abused the IRS will catch on sooner or later.
- High income: This is one of those red flags that can’t be avoided, but is good to know because it will force you to keep better records on everything since your chance of an audit is higher than most. The IRS focuses more on these returns because these are the people that bring in more than 60% of what is paid to the IRS each year. The IRS only has only so many employees to enforce the audits and going after these people will give them the most bang for their buck.
- Incomplete or messy tax return: If your tax return is not complete or is messy and cannot be read by an IRS computer then it is very likely that this return will be looked at in more detail by an IRS employee. Once an IRS employee has to look at the tax return, the chances of an audit significantly go up. It is highly suggested that you use a tax software program or hire a tax professional to compete your tax return in order to decrease the changes of the return being incomplete or messy.
- Inconsistencies from prior year tax return: The IRS likes consistency and their computers do check for changes from year to year. Even little things like getting married and changing your name can trigger a flag, but they also look for large swings income, changes in filing status, and many other factors. The IRS flags this because many times a big change can mean the person made an error, so they investigate these sorts of things in more detail.
- Being self-employed and filing a schedule C: The IRS loves to look at people’s schedule C’s in more detail. Year after year people abuse their deductions, so the IRS is very quick to question anything that is out of the ordinary. If you are self-employed and file a schedule C each year, be sure that you keep backup for every deduction you take and be extremely honest and know the rules on what is allowed and what isn’t. If you are running a legitimate business and filing a schedule C, consider making the business a separate entity from yourself so you don’t have to file a schedule C, this can significantly decrease your chances of being audited.
- State and Federal returns don’t match: If the income reported on your State and IRS returns doesn’t match the IRS will find out quickly and want to look into in more detail. Making sure that these two matches before you file is important.
- Claiming a lot of tax credits: Many times individuals claim a lot of legitimate tax credits, but statistically speaking the people that claim a lot of credits also make a lot of mistakes and claim something that doesn’t really apply to them. The IRS is always on the lookout for improper use of tax credits.
- Claiming a loss on a questionable business: The IRS has strict guidelines as to what they consider a legitimate business. The IRS makes sure that people do not flow through losses from what they consider a hobby. If the IRS believes your “business” is a hobby, they will flag your return for an audit.
Getting caught in an IRS audit is stressful, time consuming, and likely expensive. Being aware of the common red flags can help you avoid an audit or can ensure you are properly prepared for one.