One of the most common questions we receive from clients is what is my audit risk? Though this appears to be a straight forward question, the truth is as tax professionals, we are required to assume that every return will be audited. However, knowing that the IRS has only so many available resources to perform audits, a 100 percent audit-to-return ration is unobtainable. Therefore, it is important to know the common mistakes and triggers that will alert the IRS to audit your return.
Report all your income
Though this seems like common sense, it is one of the most common issues with returns. The IRS does cross reference returns with W2’s, 1099’s, and K-1’s that are filed through various government agencies. By not reporting income the IRS will send you a bill for what they believe the additional tax is. If you receive a notice for income that is not yours, contact the IRS or your tax professional immediately to get it corrected.
Using your Car for Business
A lot of people use their cars for business and have legitimate deductions and reasons to do so. But is 100% of your car used strictly for business? Do you have a separate car to take the kids to school or to run to the grocery? In most cases, a log showing your business trips and personal trips helps separate this issue to allow for a deduction for the mileage used for business. Either way, a mileage log is a necessity during any IRS audit when a vehicle is concerned.
Higher the Income, the Higher the Risk
In recent years, the IRS has increased their audits on returns reporting over $200,000 in income. For those with incomes over $200,000 you have a one in 30 chance of being audited. For those over $1 million your chance increases to one-in-nine.
Higher than Average Charitable Deductions
The IRS knows that most Americans donate to some charity throughout the year. These donations range from your church to the local youth programs. They also include both cash and non-cash donations. If you donate a large percentage of your income to charities, they will want to know how you pay your own bills. For noncash donations over $500, by not filing a Form 8283, you are raising your chances even more for the IRS to review your return. If you donate a large piece of land or property, make sure you document everything as your chances are even better you will be hearing from the IRS.
Hobby or a Business?
Is that side business actually a business or is it more along the lines of a hobby? The IRS does expect a business to make a profit, after all, isn’t that what you are in business for? It is understandable to have bad years, but you need to be able to prove to the IRS that you are engaged in the activity to make a profit. If you are constantly showing a loss, the IRS will want to look closer.
Everyone loves round easy numbers, such as $100 or $175 for an expense. By constantly showing nice round numbers, you are showing the IRS that you are more likely making numbers up then actually keeping records. It is ok to round up to the nearest dollar, just don’t round up to the closest $25 unless you can provide the records to back it up.
Excessive Travel and Entertainment
Make sure that all your business travel and entertainment costs meet the business purpose tests. The first two tests are ordinary and necessary expenses; are they ordinary in the amount of the expense and is the expense necessary for your business? The more extravagant and higher amounts claimed will flag your return for further review.
It is not illegal to have foreign bank accounts or investment accounts, it is just illegal to not report the income derived from these accounts. Be sure to report all of your offshore and foreign accounts. The IRS has taken a more aggressive stance and has obtained more treaties with other countries to obtain these records.
Simple Math Mistakes
The IRS understands that simple math mistakes will happen, especially if you’re not using a tax professional or tax software. Check and re-check all of your figures and when in doubt, contact a tax professional.
Alimony or Property Settlement
Is your spousal support alimony or a property settlement reached in your divorcee proceedings? Is your ex-spouse claiming the income on their return? Remember, alimony is deductible while a property settlement is not. If alimony turns into a property settlement, it is also no longer deductible.
The IRS has no patience for those that argue taxes are illegal or unconstitutional. This is the fastest way to get on their radar and stay there for a while. Not only could you possibly owe taxes, but you could be looking at criminal charges that could lead to jail time. Remember, this is the agency that took down Al Capone.
Use a Reputable Tax Advisor
The ethics behind your tax professional are very important. If your tax professional takes unnecessary risks with their clients and flags the IRS attention, the IRS is more likely to audit any returns they prepared, including yours.
File Your Return
Again, this is basic, you earned income, you must file a tax return. The IRS has provisions under the law that allows them to file a return for you. Does that sound like a deal, have the people responsible for enforcing the tax code prepare your return? Let them, and see how beneficial it is for you. The IRS does not know your exemptions and deductions and therefore will not give them to you. The only way to get them is to file and elect to take them.
Fred Francis is Senior Accountant at CSH specializing in IRS controversies, and a member of the firm’s Professional Services Provider Industry Group. He can be reached at 937.226.0070 or [email protected].