What Causes You To Get Audited By The IRS?
While you can’t completely prevent an IRS audit, there are steps you can take to lower your risk. The agency often reviews returns that report large amounts of cash (taxi drivers, hair salons, restaurants, and other businesses that accept tips and make many transactions in cash). Reporting deductions that are well above the norm for your profession could also trigger an audit. So, double-check your math and avoid careless mistakes.
While you can’t completely prevent an IRS audit, there are steps you can take to lower your risk. The agency often reviews returns that report large amounts of cash (taxi drivers, hair salons, restaurants, and other businesses that accept tips and make many transactions in cash).
Reporting deductions that are well above the norm for your profession could also trigger an audit. So, double-check your math and avoid careless mistakes.
1. Not Filing Your Taxes on Time
One of the most common mistakes people make is filing their taxes late. This triggers a red flag and may increase the likelihood of an audit. You can avoid this issue by using tax software that walks you through the process and reminds you of due dates.
Another red flag is making large deductions on your return that you’re not able to substantiate. For example, claiming a home office or meals and entertainment expenses, especially if your business is not generating much income, can raise eyebrows. If you do this, keep careful records and receipts.
The IRS also pays close attention to Schedule C returns, which detail profit and loss for sole proprietorships. They’re looking for self-employed individuals who overstate deductions or underreport their income. Those who operate cash-intensive businesses (such as bars, hair salons, and taxi services) are also at higher risk for an audit.
Math errors are another red flag that could trigger a review. However, they’re not likely to lead to a full-blown audit. If an automated process spots a math error, the IRS may simply notify you and propose a resolution. Other errors, such as failing to report foreign assets or reporting inaccurate information on a form, could be more serious and require a full-blown audit.
2. Making Mistakes On Your Taxes
Few things strike fear into the hearts of taxpayers, like the words “IRS audit.” While the odds of being flagged for a full-blown exam are still relatively small (less than one-third of 1%), some mistakes can dramatically increase your chances of landing on the IRS’ radar screen.
Math errors are often the first red flag that an examiner will notice, and clerical mistakes like transposing digits or forgetting to file a form or schedule can also trigger an audit. But these types of errors can be easily corrected by the IRS, which will refigure your tax return for you and send you a letter explaining the corrections.
Other mistakes that could land you in hot water with the IRS include claiming excessive deductions such as travel and entertainment or failing to keep thorough records of those expenses. It’s also easy for personal and business assets to get mingled when running a business, which can draw the attention of an IRS auditor.
Lastly, if you run a cash-based business such as a nail salon or restaurant and claim substantial tips and other income, the IRS will be alert for possible underreporting. You’ll also be more likely to be audited if you have more than $10,000 in foreign financial accounts and don’t file the required Foreign Bank Account Reports (FBAR). Regardless of how large your bank balance is, you should always report all of your income, even if you’re unsure you’ll qualify for certain credits or deductions.
3. Not Keeping Good Records
There’s a good chance you’ll get audited by the IRS at some point, but you can reduce your odds significantly by keeping detailed records and documentation of your deductions and donations. This includes charitable contributions, home office deductions, and other common tax breaks, meals, and travel expenses.
The IRS often audits returns based on red flags that they find suspicious. For example, large inconsistencies in income from year to year usually prompt an agent to take a closer look. A sudden increase in net worth and a decrease in the number of W-2s you receive are also cause for suspicion.
Also, the IRS pays attention to Schedule C income from high-grossing sole proprietorships and cash-intensive industries (taxi drivers, car dealerships, and restaurants) and unsubstantiated losses that can offset other reported income, such as wages. They also review cash-intensive businesses like laundromats, mobile cart vendors, bed and breakfasts, and storage companies.
Also, claiming 100% business use of a vehicle is a big red flag to the IRS, especially when it’s accompanied by poor recordkeeping. The IRS prefers to see a log of mileage along with precise calendar entries specifying the starting and ending locations and business purposes for every road trip you claim as a business expense.
Sloppy recordkeeping can result in an overstated deduction for auto mileage. Similarly, the IRS has little tolerance for individuals who attempt to take advantage of the conservation easement tax write-off by fraudulently claiming inflated property values on donated easements.
4. Not Filing Your Taxes As A Sole-Proprietorship
Being a sole proprietor can be very simple, but it also has its risks. For example, it is easy for income to go unreported or for personal and business expenses to be comingled. The IRS reviews the official income tax forms it receives (Forms 1099, W-2, and K-1) and compares them to the amounts reported on your return. If there is a discrepancy, you will likely receive an audit notice.
The IRS is especially suspicious of businesses that handle a lot of cash. For example, if you operate a convenience store, restaurant, car wash, or hair salon, you are at a higher risk of being audited. The same goes for businesses that claim large deductions. It is very easy for the IRS to disallow these deductions on audit.
Claiming the home office deduction is another red flag that may trigger an audit. You should only be claiming this deduction if you use a portion of your home exclusively for business and have the proper documentation to prove it. Sloppy recordkeeping can also trigger an audit.
Lastly, the IRS may audit you for failing to report foreign bank accounts on Form 8938. This is a requirement under the Foreign Account Tax Compliance Act. If you are not filing as a sole proprietorship, you should consider hiring a professional to help ensure your taxes are being filed correctly. They will also be able to help you determine which tax write-offs are available to you.
5. Not Filing Your Taxes As A Partnership Or Corporation
Few things cause as much dread as an IRS audit, but you can lessen your odds of getting audited by following IRS guidelines and being honest. The main way to audit-proof your taxes is to keep all your paperwork and be sure to report all your income, even if it means you’ll pay a small penalty.
Another common audit trigger is taking deductions that are out of proportion to your income, such as overstating your charitable donations or claiming too many home office expenses. The IRS compares the average deductions of taxpayers in your industry to those on your return, and if they’re too high, it could raise a flag.
In addition, the IRS is especially on the lookout for people who report large losses from hobby-sounding activities and have lots of other income. They’re looking to see if those losses are legitimate business expenses or simply a way to offset other sources of income, such as wages or investment earnings.
When you get a notice from the IRS, make sure to promptly respond so that your examiner has time to review all the information. If you disagree with the examiner’s findings, you have the right to meet with an IRS manager, seek mediation or file an appeal. If you owe any money, the IRS can also extend the statute of limitations while the dispute is being resolved.
6. Not Reporting All of Your Income
Few things strike fear into the hearts of Americans, like an IRS audit. But it’s important to remember that the odds of getting audited are actually pretty small—especially if you follow the rules and keep good records.
One of the most common reasons why taxpayers get audited is because they fail to report all of their income. This can include leaving off W-2 income, not reporting 1099 income from side gig work, or failing to report capital gains on stocks, cryptocurrency trades, or property sales. It can also include failing to claim a home office deduction or taking multiple losses on your business tax return.
People who run businesses that handle a lot of cash, such as restaurants, nail salons, car washes, and convenience stores, are more likely to be audited because they often underreport their income. The IRS is also on the lookout for anyone who consistently reports large losses from hobby-sounding activities to offset other income sources.
Wrapping Up
While many of these red flags are easily corrected by amending your tax returns, other cases are more serious and could result in criminal prosecution if you are found guilty. In order to avoid such penalties, you’ll want to seek an audit reconsideration from the IRS as soon as possible. This is best done alongside a tax professional, as penalties can continue to accumulate while you wait for the IRS to consider your request.