No one is excited about being audited by the IRS. Even though the IRS has been slammed like everyone else, there is still a chance your return will get flagged for an audit. “But why me?”
We hear you. However, the IRS audited only 0.4% of all individual returns in 2019, so your chances are already pretty slim. Those who were audited probably never saw an IRS agent in person as everything was done by mail. The pandemic may have lowered those odds if you need something that puts even a slightly rosier glow on 2020.
But, there are a few red flags the IRS will stop to look at that could increase your odds of getting that dreaded audit stamp on your return.
Failing to Report All Taxable Income
Employers, clients, banks, and other institutions are required to send the IRS the same information they send you on your W-2s, 1099s, and other IRS forms. If you made money, the IRS probably knows about it.
When you don’t report everything, the powers that be can see that what you reported doesn't match up with what they have. Then the eyebrows go up, and the IRS starts digging.
Taking High Deductions or Credits
It’s easy to go wild on those deductions and credits the IRS offers. Don’t talk yourself into believing all of them apply to you. If it’s a stretch, don’t do it. A competent tax preparer can guide you through those that are potentially OK for you to claim, but if it’s doubtful, don’t take it.
Large Charitable Contributions
Did you give clothes to charity? Don’t try to get the retail value back. Think more garage sale pricing.
Did you give to your church, donate to a cancer fund, or let an organization have a car? All laudable activities. But don’t overdo the amount you say you contributed to a charitable organization.
The IRS is going to compare your income with your charitable giving. They know what the average charitable contribution is for people in your tax bracket. If you give more than they think you can afford, you may be getting mail from them.
Claiming Business Losses or Expenses
If you are an independent contractor or own a business, be careful what you claim as a tax deduction. Some of the following can get your return flagged:
- Claiming 100% business use of a vehicle
- Deducting too many business expenses
- Claiming too many losses on your Schedule C
- Writing off hobby expenses as business expenses
Unless you can prove beyond a shadow of a doubt that your new car was used only for business, reconsider your plan to write it off as a business expense. Also, read the rules for business expenses, so you know when and how to amortize losses on capital expenditures.
Operating a Marijuana Business
This is a new one. The expansion of legal marijuana sales in the United States has led to a proliferation of new businesses. Unfortunately, marijuana businesses are prohibited from claiming business write-offs, which may come as a nasty shock to newly minted entrepreneurs.
The only expense these businesses can legally claim is the cost of the product. Why is that? Because a federal statute says you can’t claim tax deductions if you sell a controlled substance that is illegal under federal law.
Marijuana, according to Uncle Sam, is still illegal, no matter what your state says about it.
Engaging in Cryptocurrency Trading
Cryptocurrency is really tricky to deal with, tax-wise. It isn’t treated like cash. Instead, the IRS looks at trading cryptocurrency like buying and selling property. Different rules apply. When using virtual currency, you need to calculate gain or loss, meaning you need records of how much you spent purchasing bitcoin, etc. The value of the item you bought with it, plus the value of the bitcoin when you sold it, and so on and so on.
Also, the IRS is explicitly looking for cryptocurrency use. Kiplinger magazine put it like this, “The IRS is on the hunt for taxpayers who sell, receive, trade, or otherwise deal in bitcoin or other virtual currency and is using … everything in its arsenal.”
Yikes! Talk to your CPA or tax attorney before attempting this.
Using Lots of Cash for Transactions
Do you run a cash business or get paid primarily in cash for everything you provide? The IRS notices and starts to wonder if any of it is getting to you under the table.
Unfortunately, too many people have used cash to avoid paying taxes. It’s made the IRS look very closely at cash transactions.
Math Errors and Perfectly Round Numbers
If math has always been your downfall, maybe you had better have someone do your taxes for you. The IRS doesn’t give you much of the benefit of the doubt when you make a mistake.
Often, you receive a mailed notice showing you the error of your ways and inviting you to send a corrected return. However, the fact that they sent you mail tells you the IRS has pulled your return for a closer look.
Also, don’t try to make things easier on yourself by using numbers rounded to the nearest hundred dollars or anything like that unless specifically instructed to do so by the IRS. Every number on your 1040 form and your supporting documents must match. And it’s highly unlikely they will report things in $100 increments.
They may let it go if you round to the nearest dollar. Just be sure you round in the correct direction. And double-check all of your math before signing your return.
If you claim the Foreign Earned Income Exclusion or you didn’t report a foreign bank account, the IRS has the system kick out your return for further scrutiny. The Foreign Account Tax Compliance Act has stringent reporting requirements for foreign accounts.
Back in the day, you didn’t have to report these accounts. You just checked a box and went on your merry way.
Not anymore. Now you check the box and identify the institution and report the highest dollar amount in your account last year.
The way the law is applied, it seems like you can’t win. If you comply, you increase your chance of an audit. If you don’t comply, you increase your chance of an audit, plus you get hit with hefty penalties.
These are just a few of the red flags that cause the IRS to peg your return for audit. That doesn’t mean you shouldn’t take all legitimate deductions and credits. Just be careful.
When in doubt, call a reputable tax expert like Top Tax Defenders to reduce your chances of a tax audit.