Being audited by the Internal Revenue Service is a fear many people have every tax season. When that fear is present, it causes some legitimate deductions to go unclaimed. It means that you are leaving money in the hands of the IRS that is rightfully yours—and that you will never see it again. Although a tax audit can be a problem, you can avoid it by looking for these IRS audit red flags.
Even though being audited by IRS makes many people afraid of the agency, tax audits are not that common. According to Money.USNews, the odds of being audited by IRS are only 0.3 percent. That is how many individual tax returns were audited in 2020.
Here are some triggers to avoid—or you may face an IRS tax audit.
Not Reporting All Your Income
If there is one thing that will raise IRS eyebrows, it is when you fail to report all your income. It occurs most often with the self-employed, or when you receive money from various corporations, trusts, and estates. This kind of income is reported on Form K-1, and the originator sends a copy to the IRS. If you receive money from a part-time job, you must report it—and pay taxes on it. All 1099s need to be reported exactly on your tax forms.Claiming a Home Office
When you claim a home office, there are specific rules the IRS has for it. You cannot claim any space in your home even if you use the space for business.The IRS says that the space—whether in your home or a separate structure—must be exclusively and regularly used for your business. It must also be your principal place of business.
Once you can make a legitimate claim for a home office, you can claim many deductions for it. You can claim the percentage of the square footage in your home and deduct that same percentage of home insurance, utilities, repairs, maintenance, mortgage interest, and depreciation. You cannot claim any expenses in your home in spaces that are not in your home office, such as painting a room.
For the deduction, the IRS allows you to claim up to 300 square feet. You may also choose a simplified method of calculating costs (if you do not want to use the standard method), deducting $5 per square foot, with a maximum amount of $1,500. Some businesses, such as a daycare, need to have a license or certificate, or be specifically exempt from the requirement of exclusive use.
Be Careful About Reporting Business Losses
When you have a business, the IRS expects you to make a profit. The IRS will not consider it a legitimate business if you are not trying to gain from it.When you show a loss, which Steven Jon Kaplan, CEO of True Contrarian Investments LLC, says you should never do on your tax forms, you can expect an audit. You can ensure reporting a profit simply by leaving off some of your deductions. Although you must report all of your business income, there is no similar requirement for reporting expenses.
Some business types are not allowed to deduct their net operating losses. It includes partnerships, S corporations, common trust funds, corporations subject to the accumulated earnings index, and regulated investment companies.
Getting Advance Child Tax Credit Payments
In 2021, the government decided to pay half of the child tax credit for that year in advance and pay the other half after the individuals filed their tax returns. Bloomberg mentions that the IRS 2022 Audit Plan will carefully evaluate payments to ensure that those who received payments were qualified.Taking Early Withdrawals on Retirement Accounts
The IRS carefully watches for people who take early withdrawals out of their retirement accounts. There is a standard 10 percent penalty for doing so, but some exceptions do exist.Earning More Than $200,000
When you bring home more than $200,000, your chances of being audited are much greater. TurboTax reports that about 4 percent of people with such an income will likely get audited. If you make more than $1,000,000, your chances of being audited rise to 12.5 percent.One reason this group is more likely to be audited is that they would have more opportunities to invest some of their income. Investments make preparing income tax forms more difficult, and the IRS believes there is an increased possibility of omitting some important numbers from the tax forms.
Cryptocurrency Transactions
If you have cryptocurrency accounts, the IRS will look carefully at what you report. Cryptocurrency is not yet under governmental control, but the government does watch what happens—as best as it can. Assets of this type are considered like stocks and real property. Bloomberg mentions that there are now specific requirements for reporting digital assets, which were made law by the Infrastructure Investment and Jobs Act passed in 2021.Avoid Excessive Deductions
While you want to report your deductions to reduce your taxes, be careful of having much larger deductions in one year than in previous years. Especially try to avoid having many of them in areas you never claimed before, such as meals and entertainment.Also, do not use rounded numbers when claiming deductions—unless that really is the number. You also want to avoid using the same numbers that you used before. Things like inflation would usually be enough to change most costs each year.
Combining Business and Personal Deductions
The IRS will look for a combination of business and personal uses listed as one. An example would be if you own only one car and then deduct all mileage as a business expense. You need to keep accurate records of business mileage and expenses and then deduct that proportion for maintenance, insurance, gas, etc.Specific rules also apply for travel mileage, meals, and entertainment. Just because you want to take a trip somewhere does not mean you can legitimately deduct the cost from your taxes. Learn the rules and then make only legitimate claims to avoid getting audited.
Getting Unemployment Income
When COVID-19 was so devastating to many people’s finances, the government sent out a lot of money to help them. Now, the IRS wants to verify that you accurately reported how much unemployment money or government stimulus checks you received. If they suspect you underreported the total amount in 2022, you can expect an IRS audit. Bloomberg says that going after those who underreported the total amount received is one of the project goals of the IRSs 2022 Audit Plan.Knowing what to avoid on your taxes will help you avoid an IRS audit. If you have questions, talk to an accountant or a tax professional to provide tax advice and help you keep as much money as possible in your pocket.
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