Member Blog: 20 Triggers Making You an IRS Target
Reposted with Permission from Valerie Colin, CPA, MST - Shareholder, Gumbiner Savett Inc.
Most taxpayers wonder at some point how they can avoid being selected for an IRS audit. Since some returns are chosen at random, there is no way to completely eliminate the risk of an audit. But it does help to know the red flags that might catch the attention of the IRS.
For individuals, your chances of being audited depend on your income. In fiscal year 2013, returns reporting income under $200,000 stood a 0.88 percent chance of an audit. Those with incomes of $200,000 and more had a 3.26 percent chance. If your income was $1 million or more, you had a 10.85 percent chance.
The following items are likely to result in extra scrutiny from the IRS.
- Unreported income. Failure to report gambling winnings, interest and dividends, non-employee compensation (1099-MISC), K-1 items, etc. may just trigger a letter and bill from the IRS — or it could generate an audit.
- Miscellaneous itemized deductions. Breaking the 2% of adjusted gross income threshold is difficult, so large miscellaneous itemized deductions may perk the interest of the IRS.
- Very large charitable donations: The IRS has data on the average size of charitable contributions for various income levels. If you take a deduction for an amount that is much larger than the averages, you could hear from the IRS.
- Property donations: Donations of property exceeding $5,000 in value require an appraisal and extra return attachments. Appraisals are often challenged by the IRS.
- Unmatched alimony: If you take a deduction for $24,000 of alimony, your ex-spouse should be reporting $24,000 of income.
- High mortgage interest: The maximum amount of qualified home indebtedness is $1.1 million (including home equity loan). A mortgage interest deduction that is in excess of a certain percentage of the debt limit could indicate an excessive deduction.
- Gambling losses. You are allowed to deduct losses on Schedule A up to the amount of your winnings, but the IRS knows that many taxpayers do not keep the required records.
- Unreimbursed employee business expenses. These expenses may be deductible, but substantial amounts are likely to raise questions because they are frequently reimbursed by an employer. If the expenses involve travel and entertainment or auto usage, your chances of hearing from the IRS may increase further.
- Travel and entertainment expenses. Because of the recordkeeping requirements, and the fact that some deductions can be questionable, this is a ripe area for the IRS.
- Automobile usage. The IRS is aware that many taxpayers fail to keep the required records, making this a fruitful area for an IRS adjustment during an audit.
- Rental losses of a real estate professional. A qualifying individual can deduct rental losses in excess of the usual $25,000 limit. Meeting the required time limit involved in real estate activities and substantiating it isn’t easy. Checking the box on Schedule E could increase your audit chances.
- Rental losses. These could be challenged if there is no revenue from the property.
- Casualty losses. This can be a complicated area where appraisals and other outside information may be required.
- Bad debt losses. The rules for claiming bad debts can be complex. Many taxpayers lose on this issue because they cannot show a bona fide debt existed or they cannot prove when the debt became uncollectible.
- Home office. If you meet strict guidelines and use a portion of your home exclusively for your business, you can deduct the expenses and depreciation associated with the space. However, you have to show the business connection and that the space was used exclusively for business. Both can be challenged by the IRS. In general, the higher the percentage of the home claimed for business, the greater your audit chances.
- Day-trading losses. Claiming to be a stock market day trader and taking losses on Schedule C is a red flag.
- Net operating loss. If your business (sole proprietorship, S corporation, partnership) has losses, you may have a net operating loss (NOL) that can be carried back or forward to offset income in other years. You may be asked to substantiate the loss if you claim a refund for an earlier year or on a later return where the NOL is used.
- Hobby losses. Multi-year losses on Schedule C (or a pass-through entity such as an S corporation) may be scrutinized, particularly if the business is listed as one that has elements of personal pleasure, such as horse breeding, photography, or auto racing. Your audit chances increase if the losses offset substantial other income on the return.
- Repairs and maintenance. What business property owners believe is a repair and what the tax law considers a repair is often different. The IRS may require you to capitalize and depreciate expenses that you deducted.
- Zero officer salaries for an S corporation. If an S corporation is active, showing no salary for officers is a red flag.
These are only some of the items that can trigger an audit. What should you do if you have them on your return? If you are entitled to the tax breaks, it doesn’t make sense not to claim them. Just make sure you have the required records and tax law justification to back them up. If you are not sure if an item should be deducted, ask your tax adviser for a professional opinion.