Relax…And Don’t Panic, Every Problem Has a Solution!
In an audit, the government is represented by a team of well-trained specialists, including audit examiners, accountants and attorneys. If your tax return is selected for examination, you need to level the playing field. If your tax return was completed by ACR, Audit Assistance is a FREE and included in our Service Guarantee. We can also help you, even if we did not prepare your return.
Red Flags Triggering Audits
- Making Too Much Money
- Although the overall individual audit rate is about 1.11%, the odds increase dramatically for higher-income filers. IRS statistics show that people with incomes of $200,000 or higher had an audit rate of 3.93%, or one out of slightly more than every 25 returns. Report $1 million or more of income? There’s a one-in-eight chance your return will be audited. The audit rate drops significantly for filers making less than $200,000: Only 1.02% of such returns were audited during 2011, and the vast majority of these exams were conducted by mail. We’re not saying you should try to make less money — everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you’ll be hearing from the IRS.
- Failing to Report All Taxable Income
- The IRS gets copies of all 1099s and W-2s you receive, so make sure you report all required income on your return. IRS computers are pretty good at matching the numbers on those forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a 1099 showing income that isn’t yours or listing an incorrect figure for your income, get the issuer to file a correct form with the IRS.
- Taking Large Charitable Deductions
- We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared to your income, it raises a red flag. That’s because IRS computers know what the average charitable donation is for folks at your income level. Also, if you don’t get an appraisal for donations of valuable property, or if you fail to file Form 8283 for donations over $500, the chances of audit increase. And if you’ve donated a conservation easement to a charity, chances are good that you’ll hear from the IRS. Be sure to keep all your supporting documents, including receipts for cash and property contributions made during the year, and abide by the documentation rules. And attach Form 8283 if required.
- Claiming the Home Office Deduction
- Like Willie Sutton robbing banks (because that’s where the money is), the IRS is drawn to returns that claim home office write-offs because it has found great success knocking down the deduction and driving up the amount of tax collected for the government. If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs that are properly allocated to the home office. That’s a great deal. However, to take this write-off, you must use the space exclusively and regularly as your principal place of business. That makes it difficult to successfully claim a guest bedroom or children’s playroom as a home office, even if you also use the space to do your work. “Exclusive use” means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night. Don’t be afraid to take the home office deduction if you’re entitled to it. Risk of audit should not keep you from taking legitimate deductions. If you have it and can prove it, then use it.
- Claiming Rental Losses
- Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. But this $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and 750 or more hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation. But the IRS is scrutinizing rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. The agency will check to see whether they worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business.
- Business Meals, Travel and Entertainment
- Schedule C is a treasure trove of tax deductions for self-employed people. But it’s also a gold mine for IRS agents, who know from experience that self-employed people sometimes claim excessive deductions. History shows that most under reporting of income and overstating of deductions are done by those who are self-employed. And the IRS looks at both higher-grossing sole proprietorships and smaller ones. Big deductions for meals, travel and entertainment are always red flags. A large write-off here will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don’t satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.
- Claiming 100% Business Use of a Vehicle
- Another area ripe for IRS review is use of a business vehicle. When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use of an automobile is red meat for IRS agents. They know that it’s extremely rare for an individual to use a vehicle solely for business, especially if no other vehicle is available for personal use. IRS agents are trained to focus on this issue and will scrutinize your records if you make such a claim. Make sure you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy record-keeping makes it easy for the revenue agent to disallow the deduction. As a reminder, if you use the IRS’ standard mileage rate, you can’t also claim actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has seen such shenanigans and is on the lookout for more.
- Running a Cash Business
- Small business owners, especially those in cash-intensive businesses — think taxis, car washes, bars, hair salons, restaurants and the like — are a tempting target for IRS auditors. Experience shows that those who receive primarily cash are less likely to accurately report all of their taxable income. The IRS has a guide for agents to use when auditing cash-intensive businesses, telling how to interview owners and noting various indicators of unreported income.
- Engaging in Currency Transactions
- The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious-activity reports from banks and disclosures of foreign accounts. A report by Treasury inspectors concluded that these currency transaction reports are a valuable source of audit leads for sniffing out unreported income. The IRS agrees, and it will make greater use of these forms in its audit process. So if you make large cash purchases or deposits, be prepared for IRS scrutiny. Also, be aware that banks and other institutions file reports on suspicious activities that appear be designed to avoid the currency transaction rules (such as persons depositing $9,500 in cash one day and an additional $9,500 in cash two days later).
- Failing to Report a Foreign Bank Account
- The IRS is intensely interested in people with offshore accounts, especially those in tax havens, and the federal government has had success getting foreign banks to disclose account information. The IRS has also used voluntary compliance programs to encourage folks with undisclosed foreign accounts to come clean — in exchange for reduced penalties. The IRS has learned a lot from these programs and has collected a boatload of money ($4.4 billion so far). Failure to report a foreign bank account can lead to severe penalties, and the IRS has made this issue a top priority. Make sure that if you have any such accounts, you properly report them when you file your return.