An audit by the Internal Revenue Service (IRS) is something that you want to avoid. However, understanding what triggers an audit may help you better prepare your taxes and lessen your chances of being audited. Let’s take a look at some of the most common red flags for triggering an audit.
The higher your income level, the greater the chance of being audited. While audits are more likely to occur if you make more than $200,000 a year, individuals making less can still be subject to scrutiny. According to recent statistics from the IRS, those with incomes between $75,000 and $100,000 have roughly a 1% chance of being audited. That percentage increases if you make more than $100,000. Interestingly enough, only 4% of those making over $1 million get audited each year; this is because most high-net-worth individuals are careful in their tax filings and are often able to take advantage of deductions that lower their tax burden significantly.
When it comes to deductions, it pays to be accurate and conservative; inflated deductions can trigger an IRS audit as well as potentially lead to penalties and fines if you’re unable to back up your claims with proper documentation. If you claim a deduction that is out of line with what other people in similar situations typically claim on their returns—for example, claiming a large medical expense deduction when compared to other filers at your income level—the IRS may flag your return for further examination or even demand an audit.
If you are filing taxes for a business entity or partnership filing what is known as Form 1065 (U.S Return of Partnership Income), there may be certain instances where additional attention from the IRS may be warranted such as when losses start mounting up or when expenses far exceed reported income levels over multiple years in succession; this could indicate that perhaps personal funds are being used to prop up business operations which would not be allowed under current taxation laws.
The Bank Secrecy Act requires businesses to tell the IRS about cash transactions that are more than $10,000. The goal is to stop illegal activities, but a side effect is that if you suddenly have a lot of cash, and don't make enough money according to your tax records, the IRS will ask where the money came from.
If you make a deposit larger than $10,000, the IRS will be notified. Be ready to explain where and how you got that money if you want to file a tax return.
The IRS is intensifying its penalties for taxpayers who hold assets and cash in foreign countries, especially those with lower taxes than the U.S. For instance, the criteria around overseas assets have increased, as well as a more careful look at these types of tax returns.
If the IRS believes that you might owe taxes on money held in a foreign bank account, it can request access to your account information from the bank. Some foreign banks are legally required to give the IRS lists of American customers.
If you make a mistake while adding or subtracting your taxes, the IRS will most likely flag your return for an audit. However, if you use tax software to do your calculations for you, it can protect you from making this type of error.
Businesses that don't make a profit have to file tax returns too. If you disappear for a couple of years and show up again, the IRS will invite you in. Missing signatures on your return can also trigger an invitation from them.
As opposed to many other taxpayers, sole proprietors and freelancers are allowed a range of tax deductions, like ones for home office use, mileage traveled, as well as food, travel, and entertainment expenses. All these costs are totaled on Schedule C before being taken away from what you earned through your business activities- this determines your taxable income from your business.
The DIF system may flag your tax return for review if the deductions you claim are unusually high compared to others in your profession. For example, people in most professions spend 15% of their pre-tax income on business travel annually. If you claim that 30% of your pretax income goes towards business travel expenses, this would be seen as abnormal and thus trigger an audit.
With the IRS receiving copies of all information returns with your Social Security number, it's easy to miss or misunderstand some of them--especially if you have investments.
Ensure you know how much money you're making from your investments by tracking it all so that when tax season comes around, reporting to the IRS will be a breeze.
Businesses such as salons, restaurants, bars, car washes, and taxi services that mostly operate through cash are more likely to come under IRS scrutiny. This is because it's much easier for business owners in these industries to hide some of their income from the IRS given a large amount of cash they take in.
Unfortunately, audits are sometimes conducted at random by the IRS. Even if you have done everything correctly, you may still receive mail from the IRS seeking an explanation for something on your return.
If you've received an IRS audit notice, don't fret. Be sure to respond quickly and courteously to all requests, which you can find more information on their website. If there's a significant sum of money at stake, however, it might be in your best interest to seek out the help of a tax professional.
Sometimes, you may be able to easily fix the issue simply by presenting documentation that backs up the figures on your return. Many times, these audits are conducted through mail and if additional money is owed, there generally aren't any penalties associated. If you feel as though meeting the deadline isn't possible, reach out to the auditor and update them. Some of the questions can likely be squashed and a postponement granted for what remains.
The statute of limitations for the IRS on tax returns is three years, and most audits occur two to three years after filing, so you should always keep your records for at least three years. In some cases, however, it may be beneficial to hold onto records for up to six years.
The best way to avoid an audit is simply by accurately reporting all income on your taxes and ensuring that any deductions taken are reasonable and supported by proper documentation should you need it down the road in case questions arise regarding your return filing status. Of course, having an experienced accountant or financial advisor on board who understands tax laws inside and out can also help reduce any potential IRS inquiries into past filings while helping ensure all future filings remain compliant with regulations set forth by the government regarding taxation matters.