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Preparation and Documentation Are Key
Sometimes, tax returns are randomly pulled for audit regardless of what you did. However, properly mitigating common audit triggers can prevent it from happening in the first place or simply help prepare you if you get an audit notice.
Having adequate documentation and records is the best preventative measure when it comes to IRS audits. When you are able to easily and accurately reference your records, you are less likely to make mistakes inputting these items on your tax return in the first place.
If your tax return gets selected for audit, being able to easily find your records will expedite the appeal process.
The top IRS 9 triggers are up next. Additional high-priority audit triggers can be found here.
Top 9 IRS Audit Triggers
Having a major change in income or deductions compared to the prior year.
If your income suddenly skyrockets or plummets by a suspiciously large amount compared to the prior tax year, the IRS may be more likely to examine your records. With the COVID-19 pandemic causing people to lose their entire incomes– or inadvertently start a successful home-based business in less time than it would normally take– this condition may not trigger as many audits as it has in the past. However, a substantial year-over-year increase or frequent changes is apt to warrant IRS attention.
People often have little control over income fluctuations. But you should be able to document why these changes occurred, such as temporary disability or a new business environment.
Suspiciously round numbers or each number ending in 0 or 5.
Occasionally, you are likely to actually have an expense that actually was $100 even or a 1099 form reporting $15. However, if every number on your tax return looks this tidy, it tends to arouse suspicion of poor recordkeeping and estimating numbers from memory.
It is rare that every single item ends in 0 or 5. This is especially true for small business taxpayers who need to substantiate more expenses. The more items on Schedule C that end in 0 or 5, the more likely an audit becomes.
While numbers need to be rounded up or down to the next dollar (e.g. $62.49 becomes $62 and $5.51 becomes $6), estimations won’t be accepted. Note how you arrived at your totals and check that the numbers don’t look too suspicious with too many ending in 0 or 5.
You misreported your taxable income.
Wages are reported on Form W-2 and Form 1099 includes, but is not limited to, self-employment and investment income. Both series are reported to the IRS and some state tax agencies.
Math and transpose errors (e.g. entering $64,000 as $46,000) will be corrected by most tax software or the IRS automated under-reporter system. But if the misstatement of your income looks intentional and not in error, your tax return is likely to get flagged for audit.
Carefully check that you received every W-2 and 1099 you were expecting. Form 1099-NEC is now used for freelancer and contract pay of at least $600 per payer, while royalty income has a minimum threshold of $10 for Form 1099-MISC. If the 1099 forms do not match your records, or you are owed a form but do not have it, contact the payer to get a corrected form issued before you file your tax return.
You've made excessively large charitable gifts.
If you’ve donated a substantial amount to qualified charities and itemize deductions on Schedule A, it is a common audit trigger. This is particularly true of large noncash donations, and doubly so if your income is much lower than the value of your donations.
Cash donations are the easiest to prove but your noncash donations need written acknowledgment from the organization if the value exceeds $250. For extremely large gifts, like vehicles and art, you should have them professionally appraised and keep this appraisal in your records.
You are claiming home office expenses.
Self-employed taxpayers can take a deduction for the portion of their homes that are dedicated to business, and this is becoming more common as more of the workforce goes freelance. This deduction includes part of the rent or mortgage, utilities, and other related expenses. However, it is a common audit target because your home office must be regularly and exclusively used for business. Being provided with workspace by an employer or client, renting an office, or allowing other members of your household to use your home office will nullify your deduction.
A field audit where an IRS agent actually looks at your home office is relatively rare. But if the numbers reported are too generous, such as claiming more than half of a studio apartment, an examination becomes more probable. Carefully measure the square footage of your home. If you are not using a whole room, use a room divider or tape on the floor to get an accurate measurement of your work area to calculate your business percentage.
You are using your personal car for business.
The IRS expects that most people will use their personal car for business travel as it isn’t always financially feasible to have a separate vehicle for business. Similar to using your home for business, the inherently personal element of car expenses raises an audit flag.
Keep detailed mileage logs so that you can separate business from personal miles. This helps you determine if the actual cost or business mileage method is more beneficial, and it also provides an accurate picture of how much you used your personal vehicle for business. Parking and tolls are always deductible no matter which method you use, and other modes of business travel like airfare, public transit, and taxis are deductible by their actual cost. Always use a business payment mode for these instead of cash or a personal card.
Business and personal expenses are commingled.
If you don’t keep business expenses separate from your personal finances, it not only makes the tax preparation process more difficult, it also vastly increases your risk of an audit.
Separate your business and personal finances by opening separate bank accounts, bank and credit cards, and digital payment processor accounts in your company’s name. Even if you do not have a formal business entity, simply keeping these items separate from your personal finances reduces your risk and also makes it easier to retrieve relevant information when needed.
You claimed the first-time homebuyer credit between 2008-2011.
Homebuyers were eligible for a tax credit if they closed on their first home between April 8, 2008 and January 1, 2010. Taxpayers who claimed the credit in 2008 essentially had an interest-free loan of up to $7,500 that would be repaid over 15 years in the form of an additional tax while taxpayers who claimed it in 2009 and 2010 (2011 for eligible military) do not need to repay the credit if they moved out of the home within three years of the closing date.
The credit has been targeted by fraudsters and real estate speculators. Subsequently, the IRS has been scrutinizing first-time homebuyer credit claimants more closely. Carefully note when you moved in and out of the home and how long you plan to stay and keep it as your primary residence.
You have several years of missing tax returns.
If your tax returns are missing or were filed incomplete (even if just the signature is missing) then the IRS is likely to flag your account for an audit. The best thing you can do is file the missing tax returns for the years that you were supposed to file one. There are situations where you don’t have to file a tax return, usually based on income. You may still want to file a return for those years anyway in case you are due a tax refund and just so the IRS has a more accurate picture of your account.
Are there Additional Audit Triggers?
Yes. You just learned about the top 9 IRS audit triggers. However, that’s not all.
You can find the rest of the crucial triggers the IRS considers here. In fact, there are 32 additional triggers.
An Audit is Triggered. What’s Next?
If your tax return is selected for audit, you will receive a notice in the mail from the IRS. They will never notify you by phone, email, or social media. It is always sent to your last known address.
You will receive IRS Letter 2202 if the IRS requests a meeting in person, typically at your regional IRS office. It also contains instructions on how to prepare for your audit and which items in particular are being examined.
The IRS will give you a date and time for your face-to-face audit. You need to notify them within 10 days of the letter date if you cannot make it to your audit.
You may receive Letter 2205 instead, a shorter version of the audit notice which is a request for a phone call. This letter only tells you which tax years are being audited, not the actual tax matters like in the long version. The call is usually a preface to a face-to-face audit.
For all other correspondence audits, you will usually receive a CP2000 notice, or automated under-reporter notice if a specific item on your tax return caught the IRS’ attention. You must respond to the notice whether you agree with the assessment or not.
What is the chance of being audited by the IRS?
The overall audit rate is extremely low, less than 1% of all tax returns get examined within a year. However, these nine items are more likely to increase your risk of being examined.
How far back can the IRS audit?
For most personal tax matters, the IRS can audit up to the past three years. For business matters (including freelancing and most self-employment) this timeframe is extended to six years.
Does filing an extension increase the change of an audit?
This is a common misconception, but no. Demonstrating that you are aware of IRS deadlines and need more time to find your documents can even reduce audit risk in some cases.
Does the IRS check every W-2?
Yes. The IRS receives a copy of every Form W-2 that you receive. When you file your tax return, the amount you report on your tax return is checked against each one in the IRS database.
Does the IRS notify you of an audit?
Yes. You are never audited by surprise. The IRS must send you a notice by mail letting you know you are under audit.
How to Get Expert IRS Audit Help
Receiving an audit notice can be frightening. Preparing for an audit is a stressful prospect where the odds may be against you, even if you’ve been fastidious about recordkeeping and timely filings.
Tax Shark’s tax professionals have decades of experience in audit representation and tax resolution services. Our intimate knowledge of IRS procedures can expedite your audit with a more favorable outcome than self-representation. Contact us today for a free consultation.