Tax Audit. Just saying the words is enough to make most people cringe. With the April 15th tax-filing deadline rapidly approaching, we’re going to discuss the red flags that could trigger a tax audit.
Sometimes audits are chosen as part of a random sample. The rest of the time, there are a number of things you can avoid doing so as not to raise red flags. In order to avoid the likelihood of a government audit, follow these guidelines:
- Report all of your income. Make sure to file any 1099s received (from brokerage houses, miscellaneous income). The government conducts a matching audit from the payers with what you report: discrepancies are a red flag that will trigger an audit.
- A major red flag is if your business (owned) has had a loss for more than 2 out of 5 years. A business must satisfy rule of profitability (3 of 5 years) to avoid being considered a hobby (in which your profit motives are called into question).
- Avoid situations where someone might call the IRS. For example, situations may arise with disgruntled former employees (i.e. recently fired) or spouses (i.e. in the middle of a divorce) acting as whistleblowers.
- Do not exaggerate your expenses. Claiming too much for deductions (medical, charity, miscellaneous) and not having substantiation for those types of expenses can be a major red flag for the IRS.
- Additionally, if your deductions are much higher than average for your income level in your geographic area, a deviation from the mean could trigger an IRS examination.
- If you’re in a cash-basis business, it is crucial to be especially careful in properly reporting your income and expenses.
- Avoid consistently filing returns late or paying your taxes late. This is one of the most sure-fire ways to trigger an examination.
Ultimately it is your responsibility to make sure that your return is filed accurately and correctly (even if a CPA files for you). Make sure never to ignore any sort of letter from the government (and if you do get correspondence from the government, make sure to follow proper procedure as to how to respond). If you need an extension of time, you can ask for it. You may want to consider hiring a CPA for handling any audits/examinations.
As you’re preparing your returns for this year, check this list of red flags and make sure to set yourself up for success in avoiding a tax audit.
If you have any questions, contact us.