For those who itemize their tax return, understanding the differences in risk between tax deductions is highly beneficial. Not all tax deductions carry equal audit risk. Though all deductions will reduce a taxpayer’s taxable income, certain deductions carry more risk of an IRS audit than others. In part, this follows from the substantiation requirements of tax deductions. Certain deductions are more difficult to substantiate than others. There is also likely to be a correlation vs. causation element underlying the contributions of certain deductions to audit probability. The probability of an audit is very closely related to the income level of a given return. And so it may well be the case that certain deductions are more common for higher earners. This would mean that such deductions have a correlation with IRS audits, but do not necessarily cause greater risk.
In this post, we will identify and discuss a few tax deductions which have been associated with audit risk. Determining whether the association is one of causation or correlation is beyond the scope of our article here. For now, it is enough to say that these deductions are common among those who receive an audit. We will discuss what these deductions involve and the things taxpayers can do to lessen audit risk.
Audit Risk is Relatively Low Each Year
Before we identify a few of the more risky deductions, let’s first point out that the overall likelihood of an audit is quite low. Proving this statement is not difficult. Let’s just look at the statistics from a previous tax year. In 2015, for instance, only 0.84% of all tax returns were audited by the IRS. That’s less than 1% of millions and millions of tax returns! And if you want to see how unlikely it is that a typical taxpayer has an audit, you only need to look a bit closer at the data.
In 2015, for incomes between $200,000 to $499,999, only 1.54% were audited. In that same year, it took an income above $1 million before a return had a probability above 5% of being audited. For incomes between $1 million to $5 million, 8.42% were audited. But returns at that income range comprised just 0.21% of all returns! Clearly, the typical taxpayer has a very, very low likelihood of an audit.
Audit Risk & Income Levels
Income level undoubtedly contributes to audit risk. This is probably true even if high income returns do not suffer from any superficial defects. The reason for this is very simple: the IRS has a financial interest in focusing on high income returns. Audits are costly in terms of time and energy, and so it makes sense that the IRS will focus on the returns which are likely to generate large deficiencies. The substantiation requirements of other deductions may indeed contribute to audit risk. But there is no question that earning a lot of money will place a return at greater risk of audit.
Tax Deductions for Charitable Contributions
We’ve discussed charitable contributions on our blog before. Taxpayers may take a deduction for a donation to a qualified charity. There are several reasons why such tax deductions may increase audit likelihood. For one, only certain organizations qualify as charities under the IRS guidelines. Using a charity which is nontraditional or new may trigger an audit. Another reason is because contributions have substantiation requirements. These requirements actually differ depending on the size of the donation. For instance, donations of noncash property may require signed appraisals of the property’s fair market value. And cash donations above a certain amount may require written confirmation by the receiving charity. These requirements, and also the size of the donation, may lead to greater audit risk.
Tax Deductions for Business Expenses
Along with charitable contributions, other deductions which can create unwanted attention from the IRS are business related deductions. This means the home office deduction, the IRS mileage deduction, and so forth. The main reason for this is that these deductions have specific limitations. The home office deduction, for instance, only applies to that portion of one’s home specifically used for business purposes. There are rules for calculating the deduction benefit available. There are also rules pertaining to how regularly the office must be used for business purposes. The IRS mileage deduction likewise has specific limitations and a particular calculation methodology. The IRS is always on the lookout to make sure that these complex rules are followed and that no false deductions be claimed.
Tax Deductions for Medical Expenses
Another tax deduction which can increase the probability of an audit is the deduction for medical expenses. One reason for this is that taxpayers can only deduct the portion of their expenses which exceeds 10% of their adjusted gross income. So, if a person’s AGI is $100,000, only those qualifying expenses beyond $10,000 are deductible. The IRS is also on the lookout for attempts to take deductions before this 10% threshold is met. Another reason is that only “qualifying” expenses count as medical expenses. The IRS provides a long list of expenses which meet the definition of “qualifying”. If the IRS sees a deduction for medical expenses, the IRS may decide to more closely scrutinize whether those expenses are on that list.
High Earners Have the Most Audits
Again, these tax deductions may increase audit risk, but clearly the most risky thing is earning a large sum of money. The IRS wants to get the most dollars for its time and energy. This is best done by concentrating on high income returns. Here at Mackay, Caswell & Callahan, P.C., we know how to deal with IRS tax debt stemming from tax deficiencies. Due to that fact, we’re familiar with how stressful and difficult an IRS audit can be. We make sure to walk our clients through the complex process of resolving back tax debt in an efficient way. If you have back tax debt, give one of our top New York City tax attorneys a call today.