What triggers an IRS audit?
With tax season approaching, you may be wondering how likely your tax return will be audited.
The chances of your return being verified depend on a number of factors, including the complexity of your return, your overall adjusted gross income, and whether you are reporting self-employment income.
A relatively simple return where most or all of your income comes from W-2 wages is less likely to be audited than a return with many investments or with other complex situations.
As you prepare your return this year, there are a number of things to consider that could increase your risk of being audited. Some of these items may be unique to the self-employed, while others apply to a wider audience.
The IRS evaluates your tax return against statistical averages for a number of areas to identify returns that appear to deviate significantly from the average return. Part of this analysis is based on income and other percentages.
For example, taking higher than average deductions may cause the IRS to audit part of your return.
Whether it’s charitable contributions or mortgage interest, the IRS will want to verify with supporting documentation that these deductions were true and legitimate. You absolutely must take advantage of all the deductions to which you are legally entitled. However, you must be able to provide justifications and documents if the IRS would issue an audit notice.
If you have a foreign bank account, your audit risk is increased.
This is an area under increased scrutiny in recent years as the IRS has been able to obtain ownership information from offshore bank accounts. The IRS is committed to ensuring that income from these accounts is reported by US citizens.
A taxpayer is required to report not only the income, but the highest balance during the year in these foreign accounts. Failure to report these accounts and balances results in significant and costly penalties.
If you have W-2 wage income, but you are also filing a Schedule C for self-employment and you have significant losses, the IRS may want to check your return to confirm that the activity is not a pass. -time. This audit risk is heightened depending on the nature of the Schedule C you report.
For example, items like woodworking, the artist, or growing flowers are all more likely to be considered a hobby than a true for-profit business. When you use the losses from this activity to offset your income generated from other sources, the IRS is particularly interested in this type of activity.
One of the main triggers for an audit is undeclared income.
When you receive a W-2 or Form 1099 or other tax document, the IRS also receives the same documentation. It is important that you declare all this income.
For example, I have had clients who sold bonds and made no profit from the sale. Since he had no earnings, the taxpayer thought he did not need to report this income. The IRS did not have the information on the cost of these bonds, and because he had not reported this income, the taxpayer received a notice from the IRS approximately 18 months later.
If you claim to use a vehicle for business purposes, be aware that it is rare, from the perspective of the IRS, for 100% of the use of a vehicle to be for business purposes. This is particularly the case if the taxpayer does not own another vehicle.
The IRS also looks at the type of work the taxpayer does in assessing the legitimacy of vehicle operating expenses. A dentist claiming a Porsche as a business expense is more likely to be challenged than a roofer claiming expenses for a van.
So, make sure you have justification for all of your claimed expenses.
You should plan to get audited and be happy when you don’t rather than claiming an unfounded deduction and hoping to play the audit lottery and not end up being audited.
Paul Pahoresky is a partner in the accounting firm of CPA JLP. He can be reached at 440-974-1040×214 or at [email protected] Consult your tax advisor for your particular situation for additional information and advice on these matters.