IRS audit—two words that strike fear into the heart of every American. While the risk of audit in 2014 was the lowest it had been in years due to budget and staffing cuts at the Internal Revenue Service, it’s still wise to eliminate these red flags from the tax return you file this April.
Failure to report income – For many people, unreported income is easy to avoid; they get a W-2 from one employer and haven’t taken distributions from their investments. For freelancers and consultants—who have many clients—and individuals drawing funds from numerous investments, it’s a little easier to overlook sums you actually need to report. Unfortunately, the IRS will view any omission as deliberate and will issue you a bill for the difference plus fines and fees.
Failure to report foreign bank accounts – The Foreign Account Tax Compliance Act established strict reporting requirements for foreign bank accounts. Under the act, overseas banks are required to provide information on American asset holders to the IRS. Individuals with foreign assets of at least $50,000 must also report them on a special form. Forget to include the form with your tax return and the IRS will assume you’re trying to hide something. The result of this error: a painful, time-consuming audit.
Taking advantage of business expenses – Again, this red flag is most common for freelancers, consultants and other self-employed professionals. If you’re among them, you’ve probably tracked the cost of your office supplies, Internet access, phone line, office space, marketing and other qualified expenditures and deducted them from your income as a business expense. Doing so is perfectly legal. However, the IRS has determined an average for business deductions by profession. If yours is above the norm, this could trigger a closer examination.
Claiming the home office deduction – The IRS has learned over the years that many people who claim the home office deduction actually fail to meet the necessary qualifications. It has become an easy target for audits as a result. Before you make this claim, think carefully about how you use the space. It must be 100 percent exclusive to your business and the principal place you conduct business. This means you cannot claim the home office deduction if you work out of a guest bedroom, your den or your children’s playroom.
Earning a lot of money – Do you make more than $200,000 a year? If so, congratulations! However, be aware that higher earnings equate to a higher chance of audit. According to TurboTax, the IRS audited about 1 percent of people earning less than $200,000 in recent years. They audited nearly 4 percent of those earning more. Among those earning $1 million or more, the audit percentage jumps to 12.5 percent. Why do they do this? Experts believe it’s because higher incomes result in tax returns that are more complicated and contain more audit triggers.
Donating large sums to charity – Charitable deductions are an easy write-off. Plus, they make you feel good. However, if you donate a large percentage of what you earn, the IRS may see it as a red flag. Just like business deductions, they track the average charitable donation at various income levels. Donate more than they consider the norm, and your generosity could become suspect.
Fear of an audit should not keep you from taking legitimate deductions. If you can prove your expenditures with receipts and other documentation, then don’t hesitate to do so. However, you may want to consult a tax professional for additional guidance.