Tax season can be a stressful time for many Americans. The threat of an audit can add even more stress to tax season.
According to the IRS, an audit is simply a review of your accounts “to ensure that the information is reported correctly according to tax laws and to verify that the reported tax amount is correct.”
So, what are your chances of being audited? Regardless of income, your chances of being audited are quite small. Of the approximately 165 million income tax returns the IRS received in 2022, about 626,204 — or less than 0.4% — were audited.
An examination of a federal tax return can be triggered randomly, but certain behaviors are more likely to raise a ‘red flag’. According to the IRS, audits are determined by a “statistical formula” that compares your returns with those of other taxpayers. With that in mind, here are some common tax mistakes that generate more scrutiny from the IRS and what you can do to avoid them.
1. Your tax return is incomplete
“There isn’t a single thing that automatically triggers an audit, but inconsistent documentation is the most common reason you’ll receive a letter from the IRS,” said Jo Willetts, director of tax resources at Jackson Hewitt.
The federal government offers a variety of credits, such as the child tax credit, which allows parents to claim up to $2,000 per qualifying child. You have to show that you legitimately qualify for these benefits, Willetts said.
“If last year you didn’t claim any child tax credit and this year you claimed three children, that’s going to trigger a letter from the IRS,” she said.
This doesn’t always mean you made a mistake or are trying to deceive the government. You may have had a child in May 2023, and the IRS is calculating your 2022 return.
2. You made a math error or other information mistakes
While simple math errors generally don’t trigger a full audit by the IRS, they will attract extra scrutiny and delay the completion of your return. The same can happen if you type your Social Security number incorrectly, transpose the numbers of your address, and make other silly mistakes.
Filing electronically reduces these confusions, as it pulls a lot of information from previous returns and allows you to download your W-2s or 1099s directly into the system.
3. You are self-employed and do not report deductions accurately
“If you work for yourself and have legitimate business expenses, you should feel empowered to claim them,” said TurboTax tax expert Lisa Greene-Lewis. “Just make sure you have receipts and documentation to back it up.”
If you claim the home office deduction, it must be a space used “exclusively and regularly for your trade or business” — not the dining room table.
If you claim transportation expenses, you’ll need to document the mileage used for work. If you deduct 100% of your personal vehicle as a business expense, that will raise a flag, Greene-Lewis said.
4. You claim too many business expenses or losses
You are required to fill out a form called Schedule C if you have income from a business, but this complicates your return and may increase the likelihood of being contacted by the IRS.
Greene-Lewis encourages taxpayers to claim all deductions they are legitimately entitled to, but to be extremely diligent in justifying those deductions, with details and supporting documentation.
In general, the IRS algorithm is looking for deductions that are out of the norm for people in your profession: if you are a patent attorney but your travel expenses are three times higher than other patent attorneys claim, that could lead to a more detailed inspection.
If you have reported losses in your business for several consecutive years, the IRS may want to ensure that your business is legitimate.
5. Your charitable deductions are exaggerated
You can claim cash donations to recognized charities, as well as the value of a car, clothing, and other property donated. The IRS notices if these donations seem out of line with your income.
“If you claim a charitable deduction that is, like, half of your income, that’s going to raise their eyebrows,” Greene-Lewis told CNET.
6. You have unreported income
This is the big issue: employers are required to file a W-2 with the IRS that reflects your earnings, or 1099s in the case of freelancers and contractors who earn more than $600.
The IRS automatically checks if your reported income matches what your employer sent. It is also notified about interest or earnings from savings accounts, investments, and stock trades, as well as large winnings from gambling, inheritances, and almost any other type of income.
If you fail to report capital gains from cryptocurrency trades, that could trigger an audit.
Important to keep in mind
Government agencies talk to each other. If you report $20,000 in income on your tax return but, when applying for a mortgage loan backed by the Federal Housing Administration, you put down $80,000, that will raise a flag.
Source: CNET