While it’s impossible to know whether you’re likely to undergo an IRS audit, there are red flags that can attract unsolicited attention from the federal tax agency. What are your chances of being audited? Read on.
The Issue
In recent years, the Internal Revenue Service has audited under 1% of all individual tax returns. That’s likely little solace if you’re targeted for an audit, which typically is solely handled by mail but still can be stressful.
The possibility that you’ll be audited escalate depending on factors including reported income, your deductions, and whether you’re engaged in a business or own foreign assets.
What’s an IRS Audit?
It’s an examination of an organization’s or individual’s accounts and financial information. It’s done to ensure that the information and reported amount are accurate.
Passed last year, the Inflation Reduction Act gives the agency an extra $80 billion over the next decade, with a good portion going toward enforcement activities.
IRS Red Flags
Not Reporting All Taxable Income: Make sure all required income is reported on your 1040 return, since the agency receives copies of all the W-2s and 1099s you get. Count on IRS computers to pick up a mismatch.
Not Filing: High-income non-filers – those earning more than $100,000 – are commonly targeted by the agency. Collections officers will first contact you to help resolve the issue. Noncompliance can result in liens, levies, or criminal charges.
High Income: New enforcement funds will go partly toward auditing high-income taxpayers, among others, as well as limited liability companies and partnerships. The bottom line is that the more you bring in, the more likely you’ll be visited by agents.
Excessive Deductions: It can be a red flag if, compared with your income, you have higher-than-average deductions, credits, or losses. Still, if they can be properly documented, you definitely should claim your deductions.
Disproportionately Large Charitable Deductions: Charitable donations not only make you feel good, but they can be written off on your taxes. But, careful: the IRS knows the average amount donated by those in your income bracket. So, be sure you don’t wind up with an IRS tax problem.
Business Owner: Self-employed people often draw IRS attention because they’re generally known for claiming excessive deductions and not reporting all their income. At higher risk are restaurants, hair salons, bars, car washes, and taxi companies.
Another red flag is claiming that a vehicle is 100% used for business. Be certain to keep detailed mileage records and exact calendar entries for every road trip.
Large Losses from Hobbies: The IRS will take a close look at you if you report multiple years of losses on Form 1040’s Schedule C, run something hobby-like, and have plenty of income from other sources. It seeks out taxpayers who repeatedly report substantial losses to help offset other income.
To qualify for loss deductions, the activity you’re running must be done so in a business-like way. You also must have reasonable expectation of turning a profit.
Early IRA Payouts: The IRS pays special attention to payouts from traditional IRAs or 401(k)s and other employer retirement plans to those under age 59.5. Such withdrawals are subject to a 10% penalty plus the regular income tax.
Not Reporting Gambling Winnings: Recreational gamblers such as those who hit slot machines or bet on horses are required to report winnings as “other income.” Not doing so can attract IRS attention, particularly if the racetrack or other venue reported the winnings on Form W-2G.
This should give you a reasonably good idea of your chances of being audited. As long as you have an effective tax consultant, and are reporting appropriately to the IRS, you have nothing to worry about.