6 Ways to Increase Your Chances of an IRS Tax Audit

Posted February 13, 2012 in by

 

The deadline for filing your income tax return is rapidly approaching. Filers are often tempted to fudge the facts on their tax returns in an effort to get a bigger refund. But that tactic can backfire on you, resulting in an Internal Revenue Service Audit. Here are six of the more common ways of increasing your chances of an audit.

6. Suffer certain types of losses. If you claim a business loss or rental property loss, it may send up red flags. In recent years, many people have decided to go into business for themselves, and ended up with expenses that exceed their business income. Taxpayers often try to deduct hobby expenses as a business loss (“I really expect my cat circus to turn a profit!”), and if they don’t think your business stands a reasonable chance of succeeding, your loss may be denied. Real estate rental income, on the other hand, is usually considered passive income and losses may not deductible.

5. Claim that your car is used only for business. The IRS knows that few automobiles are used strictly for business—and it’s wary of taxpayers who claim 100% business use of their motor vehicle. If you’re making such a claim, you’d better have the documentation to back it up.

4. Take higher-than-average deductions or claim exceptionally large charitable contributions. It’s no surprise that the IRS compares your return to the average return of other taxpayers reporting similar income levels. If you’re paying less tax because you’re taking much bigger deductions, it sends up a warning flag and may trigger an IRS tax audit. (Before you file your tax return, some tax-prep software will tell you how your return compares to other returns in the same income bracket. It’s a useful guide to knowing how your return stacks up.)

3. Claim a home office deduction. For years, taxpayers have viewed the home office deduction—which allows you to deduct a portion of your rent, mortgage payment, real estate taxes and utilities—as an easy way to reduce their tax bill. But the IRS takes a firm position on what does and does not qualify as a home office. Before you deduct your home office, read the rules carefully to ensure that yours qualifies.

2. Don’t report all of your earned income. Remember those W-2s and 1099 forms you’ve been receiving? Well, you’re not the only one — the IRS gets a copy, too. If you forget to include some of that taxable income on your tax return, the IRS will notice. And don’t think you’re off the hook if a company forgets to send you a W-2 or 1099. The IRS expects you to report the income even if you’re missing the documentation.

1. Earn more than $200,000 a year. On average, the Internal Revenue Service audits 1.11% of all returns. But the audit rate increases as your income rises. For those who earn at least $200,000, the audit rate is 3.93% of all tax returns. And if you earn a cool million annually? You have about a one-in-eight chance of being audited.

Bonus: Make a math error. There are formal IRS audits, and then there are unofficial audits. The formal kind is what most people fear. But if you make a silly mistake on your return—such as a math error in your favor—the IRS will spot it. Last year, 4.7 million taxpayers got letters from the IRS notifying them that they’d made a mistake and owed more money. But that letter from the IRS doesn’t always bring bad news—another 4.6 million learned their corrected mistakes actually entitled them to a bigger refund.

 

If You’re Notified of an Audit

So what happens if the IRS tells you that you’re being audited? First, it’s important to remember that being selected for an audit doesn’t automatically mean you’re guilty of doing anything wrong. There may have been something in your tax return that got you flagged for an audit, or you may have been randomly selected.

Burton J. Haynes

“Most normal people dread an audit,” says Virginia-based tax lawyer Burton J. Haynes. “At best, it takes time and perhaps money for legal and accounting help. At worst, it can reveal understatements of income and overstatements of deductions, or even intentional fraud warranting prosecution and prison. Very few audits become criminal cases, but it does happen.”

Haynes says that the better your recordkeeping and the more accurate your tax return, the less concerned you should be if you’re notified of an audit. That said, it is a legitimate cause for worry for some taxpayers.

“For many it is merely an inconvenience, though for some a costly inconvenience,” Haynes says. “And for an unfortunate few, it is the beginning of a road that leads to criminal investigation, prosecution, incarceration, humiliation and ruin. Thus the lesson is to avoid giving the IRS a stick to beat you with, lest you wind up broke and with lumps on your head.”

Tagged as: , , , , ,