IRS Audit Red Flags:
The Dirty Dozen
Here are 12 hot spots on your return that
can raise the chances of scrutiny by the IRS.
1. Failure to report all taxable income.
The IRS receives copies of all 1099s and W-2s that you receive during a year, so make sure that you report all required income on your tax return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill.
2. Returns claiming the home-buyer credit.
First-time homebuyers and longtime homeowners who claimed the homebuyer credit should be prepared for IRS scrutiny. Make sure you submit proper documentation when taking this credit. First-time homebuyers have to attach a copy of their settlement statement to the return, and longtime homeowners should also attach documents showing prior ownership of a home, including records of property tax and insurance coverage. All claims for this credit are being screened.
3. Claiming large charitable deductions.
This comes up again and again because the IRS has found abuse on audit, especially with those taking larger deductions. We all know that charitable contributions are a great write-off and help you to feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared to your income, it raises a red flag.
4. Home office deduction.
The IRS is always very interested in this deduction, primarily because it has a pretty high adjustment rate on audit. This is because history has shown that many people who claim a home office don't meet all the requirements for properly taking the deduction, and others may overstate the benefit.
5. Business meals, travel and entertainment.
Schedule C is a treasure trove of tax deductions for self-employers. But it's also a gold mine for IRS agents, who know from past experience that self-employeds tend to claim excessive deductions.
6. Claiming 100% business use of vehicle.
Another area that is ripe for IRS review is use of a business vehicle. When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use for an automobile on Schedule C is red meat for IRS agents.
7. Claiming a loss for a hobby activity.
Your chances of "winning" the audit lottery increase if you have wage income and file a Schedule C with large losses. And, if your Schedule C loss-generating activity sounds like a hobby -- horse breeding, car racing and such -- the IRS pays even more attention.
8. Cash businesses.
Small business owners, especially those in cash-intensive businesses -- taxi drivers, car washes, bars, hair salons, restaurants and the like -- are an easy target for IRS auditors. The agency is well aware that those who primarily receive cash in their business are less likely to accurately report all of their taxable income
9. Failure to report a foreign bank account.
The IRS is intensely interested in people with offshore accounts, especially those in tax havens. U.S. tax authorities have had some recent success in trying to get foreign banks (such as UBS in Switzerland) to disclose information on U.S. account holders.
10. Engaging in currency transactions.
The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious activity reports from banks and disclosures of foreign accounts.
11. Math errors.
One of the biggest reasons that people receive a letter from the IRS is because of mathematical mistakes they make on their tax returns. If you make an error in your favor, you are going to hear from the tax man, and there is a greater risk of the IRS pulling the whole return for audit.
12. Taking higher-than-average deductions.
If deductions on your return are disproportionately large compared to your income, the IRS audit formulas take this into account when selecting returns for examination. Screeners then pull the most questionable returns for review. But if you've got the proper documentation for your deduction, don't be scared to claim it. There's no reason to ever pay the IRS more tax than you actually owe.
