6 Tax Audit Red Flags

Here it comes.  April 15th.  The date otherwise known as the annual deadline for filing income taxes.  In the past year, the IRS has faced some significant budget cuts, meaning that staffing numbers have been reduced when compared to previous years.  That means that taxpayers across the country may face a lessened chance of actually being audited.  However, realize that this is a cautionary tale—and not everyone is going to get off so lucky.  Learn about the red flags that make your chances of being audited by the IRS higher.

Things to be Aware of

  1. If you run a small business—you need to be able to prove it.  It’s true that few people immediately make a profit when they start their own business, and a loss is acceptable by the IRS—at least up to a point.  If you start reporting losses for three years or more, the IRS is going to begin to assume that your “business” is more of a hobby and that you aren’t looking to make this a venture that will ever be profitable. This can ultimately activate a field audit, a process that happens one-on-one, in-person, and is significantly more difficult than a simple correspondence audit.   In order to avoid this, keep meticulous records that show that you were dedicated to your business, the time you spent on it, and other supporting materials.
  2. If something looks odd, explain it.  The IRS searches for instances of unreported income, so if you look to explain something in advance that looks off or odd, you reduce your risk for being audited.  A for instance: your net income is low. In this regard, include a statement that explains how you handled yourself financially—whether you ran up your credit cards or tapped into savings, etc.  Providing this information can help in the long run.
  3. Report all of your income.  The majority of your wages are going to be found on W-2 forms.  Interest, dividends, and capital gains will be reported on 1099 as well as income you earned through contracting or freelancing work.  Realize that these forms are not only sent to you, but also to the IRS, and there is an automated process that is used for ensuring you have reported these documents. Therefore, don’t pretend you didn’t receive something—the IRS will send you a bill in the mail for any additional amount that you owe, and the agency has the right to garnish your bank account and seize property.
  4. Report any money overseas.  U.S. taxpayers who have bank or investment accounts abroad are required to report any income they earned on these accounts to the IRS.  Moreover, a recently established law, called the Foreign Account Tax Compliance Act, means that a foreign financial institution might start reporting this income to the IRS directly.  If you have had an account for several years and have never reported it to the IRS, you could face some serious penalties and back taxes if the agency catches wind of it.
  5. Watch the home office deductions. Most people have one primary office, either on company property or in a home.  Therefore, don’t report a deduction for both if you cannot explain why you have two offices.  Moreover, if you have a primary office through your company that is available for you to use the majority of the time, it’s recommended that you skip taking a home office deduction at all. It’s a huge red flag.
  6. If you sold your home, report it.  The title company will end up sending you and the IRS a 1099-S form that records the proceeds from this sale.  Even if all proceeds are tax exempt because they don’t exceed federal limits, it’s necessary to report the information on the 1099-S anyway.  This again comes back to the fact that the IRS matches forms through an automated program and not reporting this could trigger a correspondence audit.  While you may very well be in the right, it’s still a headache you don’t need.

In closing, an IRS audit is a headache that no one wants to deal with.  As the April 15th tax deadline approaches, make sure you consult with a trusted and ethical accountant to protect your interests and ensure that you are following all of the rules to a “t.”

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