Every year, millions of Americans file their taxes, hoping to avoid any unwanted attention from the IRS. While only a small percentage of taxpayers face audits, it’s crucial to understand what might trigger an IRS audit and how to minimize your risk.
The IRS has a complex algorithm with a variety of factors they take into account when assessing a potential audit. In this article, we’ll delve into the top 10 most common IRS audit triggers and provide expert tips to help you stay off the IRS radar.
Here are some Very Common IRS Audit Triggers
1. Failing to Report All Income
The IRS receives copies of all your income-related forms, such as W-2s and 1099s. Failing to report all your income can raise red flags. To avoid this trigger, ensure you report all your income accurately and double-check your records. It may sound simple, but it could save you from an audit.
Whether it’s a cash payment that you did not record or a 1099 income form that you misplaced, missing records are one of the biggest red flags for the IRS.
2. Excessive Deductions
Claiming unusually high deductions compared to your income may draw IRS scrutiny. Review the standard deduction amounts and ensure your itemized deductions are within the acceptable range.
The best way to ensure accuracy in deductions is to track all of your expenses as they come, and work with a tax professional at year’s end to ensure that you are allocating your expenses in the right categories.
3. Inaccurate or Incomplete Information
Mistakes or discrepancies in your tax return can prompt an audit. Double-check your Social Security number, filing status, and dependents’ information to minimize errors.
4. Home Office Deduction
The home office deduction has specific requirements that many taxpayers overlook. Ensure your home office meets the IRS criteria, such as exclusive and regular use, before claiming the deduction.
11. Foreign Bank Accounts and Income
Failing to report foreign bank accounts or income can raise IRS suspicions. Be sure to comply with the Foreign Account Tax Compliance Act (FATCA) and report any foreign income or assets.
6. Large Charitable Contributions
While donating to charity is commendable, the IRS may question excessive charitable deductions. Keep receipts and records for all charitable contributions, and be prepared to substantiate your donations.
7. Unusually High Income
Taxpayers with higher incomes are more likely to face audits, as there’s a higher potential for tax revenue. Maintain thorough documentation of your income sources and deductions to streamline the audit process if necessary.
For example, if you have been making $50,000 per year for the last couple of years and suddenly make $200,000, the IRS may be more likely to review your return.
8. Claiming Rental Losses
Claiming rental losses can be a red flag, especially if you’re not actively involved in managing the property. Familiarize yourself with the IRS guidelines for passive activity losses and adhere to the requirements.
9. Owning a Cash-Based Business
Cash-intensive businesses, such as restaurants and bars, are often targeted for audits due to the potential for unreported income. Maintain accurate and detailed records of all transactions to reduce the risk of an audit.
10. Filing an Amended Return
Amending a return can attract the IRS’s attention, especially if it involves significant changes. Consult a tax professional to ensure your amended return is accurate and complete. This is especially important if the amended return may result in a refund. In these cases, the IRS may look more closely at your tax return to make sure it is accurate and compliant.
11. Cryptocurrency Transactions
The IRS is increasingly scrutinizing cryptocurrency transactions. Accurately report your crypto-related income, gains, and losses to avoid triggering an audit.
Keep in mind that most of the major cryptocurrency platforms are now required to provide the IRS with user data for tax reporting purposes. Therefore, it’s crucial that you report all of your crypto-related income accurately and in a timely manner.
Remember, the best way to avoid an audit is to file accurate returns in the first place. Staying up to date with changes in tax laws and filing your returns carefully and accurately can go a long way toward avoiding an audit.
The IRS Audit Process: What to Expect
Understanding the different stages of the IRS audit process can help alleviate anxiety and prepare taxpayers for a potential audit. Here’s a brief overview of what to expect:
- Initial Notification: The IRS will typically notify you by mail if your tax return has been selected for an audit. This letter will outline the specific items under examination and the documentation you’ll need to provide.
- Types of Audits: There are three main types of IRS audits – correspondence, office, and field audits. Correspondence audits are conducted via mail, while office audits require you to visit an IRS office. Field audits are the most comprehensive and involve an IRS agent visiting your home or business.
- Examination: During the audit, the IRS will review your documentation and financial records to verify the accuracy of your tax return. The examination process may involve interviews, requests for additional documentation, or even third-party confirmations.
- Outcome: Once the examination is complete, the IRS will issue a report detailing its findings. You may agree with the results and make any necessary adjustments, or you may dispute the findings and appeal the decision.
Statute of Limitations for IRS Audits
Knowing the statute of limitations for tax audits can help taxpayers stay informed and prepared. Here’s what you need to know:
- General Rule: The IRS typically has three years from the due date of your tax return or the date you filed it (whichever is later) to initiate an audit.
- Exceptions: The statute of limitations may be extended to six years if you’ve understated your income by more than 25%. In cases of fraud or failure to file a tax return, there’s no time limit for the IRS to initiate an audit.
- Amended Returns: If you file an amended return, the IRS generally has three years from the date you filed the amendment to audit your return. However, the overall statute of limitations for the original tax return still applies.
What should you do if you are being audited by the IRS?
If you’re facing an IRS audit, it’s essential to be prepared with a solid defense strategy. Here are some tips to help protect yourself during an audit:
- Substantiate Deductions: Gather and organize all necessary documentation to support your claimed deductions, such as receipts, invoices, and bank statements. Providing clear, accurate records can help reduce the likelihood of additional scrutiny.
- Know Your Rights: Familiarize yourself with the Taxpayer Bill of Rights, which outlines your rights during an IRS audit. This includes the right to professional representation, the right to appeal, and the right to privacy and confidentiality.
- Consult a Tax Professional: Enlisting the help of a tax professional, such as a CPA or Enrolled Agent, can be invaluable during an audit. These experts can help you navigate complex tax laws, communicate with the IRS, and negotiate penalties or additional taxes on your behalf.
- Stay Organized and Responsive: Respond promptly and professionally to IRS requests for information or documentation. Staying organized and maintaining open communication can help facilitate a smoother audit process.
How do I avoid an IRS Audit in the first place?
While there’s no foolproof way to avoid an IRS audit, understanding the common triggers and taking steps to minimize your risk can help. Accurate record-keeping, adhering to IRS guidelines, and working with a tax professional can ensure that your taxes are filed accurately and on time.
If you’re concerned about an IRS audit or need help with IRS audit representation,
Contact our team of experienced tax professionals for personalized assistance.