Is Your Tax Return the Next IRS Audit?

Is Your Tax Return the Next IRS Audit?

Tax filing season is here!  For those of you receiving a refund, you probably have already filed your tax return.  High income earners and self-employed individuals with a balance due are probably waiting until last minute.  Regardless if you have a refund or balance due, chances are that once your tax return is filed and accepted you forget about taxes until the same time next year.

So what happens to your tax return once it has been accepted by the IRS?  Does this mean you are in the clear?  Just because you received your refund or paid any additional taxes that were due, does not mean that you are free and clear of any further actions on behalf of the IRS.  Over the course of the next few years, your tax return may be subject to more scrutiny and deeper analysis, with the IRS searching for more fraud flags that could still trigger a full and complete audit of your tax returns.  The IRS has up to three years after you file your tax return to audit and asses additional taxes.  If the IRS suspects that you may have committed fraud on your tax return, the audit period is indefinite.

10 Common Audit flags:

1. Not reporting income: The IRS receives copies of all 1099s and W-2s you receive, so make sure you report all income on your return. If you receive an incorrect 1099, talk to the issuer and make sure that a corrected form is filed with the IRS.

2. A large change in income: The IRS computers have all of your historic data, so when there's a big change from the previous year, it can trigger a red flag.

3. Being self-employed: Self-employed workers take note: The IRS doesn't trust you, because so many of you are trying to game the system by under-reporting income and overstating deductions. This class of taxpayer must be well-prepared to defend all deductions and credits.  Just because your received cash or did not receive a Form 1099 for that side job you did for your friend, does not mean that it isn’t income.  The IRS uses statistics such as www.bizstats.com for each trade to properly determine if you are reported the proper income and deductions for your trade.

4. Taking higher-than-average deductions: If deductions on your return are disproportionately large compared with your income, your return may get flagged. To defend yourself, make sure you have documentation.

5. Large charitable contributions: Many of you donate 10% of your income to your church. You must keep proper documentation such as copies of cleared checks or credit card receipts, if you donate cash you must show how it was obtained such as bank withdraw, and you must get written acknowledgement from the organization.

6. Small business losses: The IRS has plenty of experience with taxpayers who try to claim losses on a small business, when the activity is really a hobby. What's the difference? A business must be entered into and conducted with the reasonable expectation of making a profit.  The IRS has a rule that states “the activity is carried on for profit if it makes a profit during at least three of the last five tax years.” This mean you should only have a loss for the first two years of the business. Special circumstances may apply.

7. Claiming dependents that are not a qualifying child or relative: Many taxpayers claim children on their tax return that are not qualified dependants.  A qualifying child is the taxpayer’s child, stepchild, foster child, brother, sister, stepbrother, stepsister, or descendant of any of them.  A qualifying relative is the taxpayer’s parent, grandparent, aunt or uncle.  There are other requirements such as you must as well.   

8. A home office deduction: Are you sitting in your kitchen, checking your work e-mail? Well, that's not a home office, according to the IRS. To qualify for this widely abused deduction, the room must be for work-only. If you really do maintain a home office, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs.

9. Large business meal and entertainment deductions: Wouldn't it be nice if every meal and trip could be easily classified as a tax deduction? Before you claim that big deductions for meals, travel and entertainment, remember they are big-time audit flags. Keep detailed records that document the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting.  Expenses must be ordinary and necessary to conduct your day to day business activity.

10. 100% business use of a vehicle: Claiming 100% business use of an automobile is not just a red flag, it's a red flag on steroids, because very few people use a car exclusively for business. No matter what percentage you're deducting, keep detailed mileage logs and precise calendar entries for the purpose of every road trip.

Bottom Line

Tell the truth; be honest when you are filling out your tax return.  If you have a deduction that’s of the common audit flags and you have supporting documents to prove it, go ahead and take it.  If your business has suffered a loss and you have documents to prove it, go ahead and report it.  The only reason you should be worried about an audit is if you are cheating on your taxes.