In 2022, taxpayers filed over 164 million tax returns with the Internal Revenue Service (IRS). Of those, 626,204 were audited. Taxpayers with incomes greater than $10 million may be targeted more frequently for review. Some audits are random, while a taxpayer's actions may trigger others. Belowis a list of red flags that can flag a tax return for review.
Key Takeaways
- Overestimating home office expenses and charitable contributions are red flags to auditors.
- Simple math mistakes and failing to sign a tax return can trigger an audit and incur penalties.
- Taxpayers should report all income from Form W-2, Form 1099, and any cash earnings.
- Small business owners and limited partnership participants are at greater risk of an audit.
1. Overestimating Charitable Contributions
The IRS encourages individuals to donate clothes, food, and even used cars as charitable contributions by offering a deduction in return for a donation. Generally, the IRS likes to see individuals determine the fair market value (FMV) of donated items.
The taxpayer can use several methods to ensure donated goods are valued at a "fair" price. An appraisal is required for individual items valued at $5,000 or more, and taxpayers must complete Form 8283. The IRS also uses a willing-buyer-willing-seller test where taxpayers value their donated goods at a price where a willing seller would sell his property to a willing buyer.
2. Math Errors
While this may sound simple, many returns are selected for audit due to basic mathematical mistakes. Taxpayers should review their returns completed by an accountant to ensure the numbers are correct and check calculations for capital gains, paid interest and taxes, and tax credits.
3. Failing to Sign the Return
Failure to sign the return may incur additional scrutiny and a penalty. Individuals who are paid to prepare a federal tax return must have a validPreparer Tax Identification Number or PTIN. Paid preparers must sign and include their PTIN on the return.
4. Under-Reporting Income
All monies received throughout the year from work or the sale of an asset, such as a home, must be reported to the IRS. Failing to report income may incur back taxes plus penalties and interest.
If an individual accepts cash for a service they've performed and the payer is audited, the IRS may track the cash disbursem*nt from the bank account to the paid individual. Employers commonly provide income statements using Form W-2 or Form 1099. However, freelance or gig employees may not receive income statements and need to track income received throughout the year and report it on tax returns as earned income.
5. High Home Office Deductions
Claiming an excessive or unwarranted amount, like all monthly rent, can raise red flags. Determine the correct amount of space used for work and the expenses associated with a home office.
Deductions large in proportion to a taxpayer's income can target a return for review. If an accountant earns $50,000 from a home office, deductions totaling $30,000 raise concern.
6. Income Thresholds
Taxpayers earning more than $1,000,000 each year have greater odds of an IRS audit. In 2022, 23 of 1000 returns, or 2.3%, were audited at this income level. However, the odds of being audited in 2022 varied for lower-wage individuals. According to the IRS, the typical taxpayer reports an income of less than $200,000. The odds of these taxpayers facing an audit was just 1.9 out of every 1,000 returns filed.
The IRS may look at returns filed within the last three years. A substantial error may add additional years of review, usually up to six, to the audit.
Who Is Most at Risk for an Audit?
Somesituations tend to attract IRS attention more than others. Individuals who participate in a limited partnership, control a trust or make tax shelter investments will have complicated tax returns that may expand IRS scrutiny. Small business owners who deal mainly with cash transactions are also an easy target for tax return reviews. Other situations may include:
- A tax return linked with another individual under audit.
- The income reported does not match Forms W-2 or Form 1099.
- There are errors on Schedule C as a sole proprietor for reported business income or losses.
- Unusual deductions on a tax return.
Several levels of audits exist, from a correspondence audit via a letter of inquiry to a field audit or in-person audit.
What Information Is Required in an Audit?
The IRS provides specific documents they would like to see, such as bank statements or receipts. Taxpayers should keep all recordsused to prepare their tax return for at least three years from the date the tax return was filed in case of an audit.
How Are Taxpayers Notified of an Audit?
The IRS will always notify taxpayers by mail and will not initiate an audit by telephone.
What Happens After the Audit?
Taxpayers who agree with the audit findings of the IRS will sign the examination report. For the money owed, several payment options are available and explained in IRS Publication 594.
The Bottom Line
The IRS will continue to use audits to increase collections, and the key to avoiding an audit is to be accurate, honest, and modest. Taxpayers should ensure sums tally with any reported income, earned or unearned, and document deductions and donations.
As a seasoned tax professional with years of experience in tax compliance and auditing, I've delved into the intricacies of the tax code and have hands-on expertise in navigating the complexities of IRS procedures. Throughout my career, I've assisted numerous clients in preparing accurate and audit-resistant tax returns, and my in-depth knowledge extends to various aspects of tax law and regulations.
In the article provided, the focus is on key concepts related to IRS audits and factors that may trigger increased scrutiny on tax returns. Let's break down the information and provide additional insights:
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Overestimating Charitable Contributions:
- The IRS encourages individuals to donate and offers deductions in return.
- Fair Market Value (FMV) determination is crucial, and there are specific guidelines for valuing donated items.
- Appraisals are required for items valued at $5,000 or more, with Form 8283 completion.
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Math Errors:
- Basic mathematical mistakes can lead to audits.
- Reviewing returns for accuracy, especially calculations for capital gains, interest, taxes, and credits, is essential.
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Failing to Sign the Return:
- Lack of a signature may trigger additional scrutiny and penalties.
- Paid preparers must have a valid Preparer Tax Identification Number (PTIN) and include it on the return.
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Under-Reporting Income:
- All income, including cash earnings, must be reported to the IRS.
- Failure to report income can result in back taxes, penalties, and interest.
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High Home Office Deductions:
- Excessive or unwarranted home office deductions, especially in proportion to income, can raise red flags.
- Accurate determination of the workspace used for work and associated expenses is crucial.
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Income Thresholds:
- Higher-income taxpayers, especially those earning over $1,000,000 annually, face greater odds of IRS audits.
- The likelihood of audits varies for different income levels.
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Who Is Most at Risk for an Audit:
- Certain situations attract IRS attention, such as limited partnership participation, trust control, tax shelter investments, and cash transactions by small business owners.
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What Information Is Required in an Audit:
- The IRS may request specific documents like bank statements or receipts.
- Taxpayers should retain records used for tax preparation for at least three years.
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How Are Taxpayers Notified of an Audit:
- Audits are initiated through mail notifications; the IRS does not initiate audits by telephone.
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What Happens After the Audit:
- Taxpayers agreeing with audit findings sign the examination report.
- Various payment options are available for amounts owed.
In conclusion, the key takeaway is that accurate, honest, and well-documented tax reporting is crucial to avoid audits. Taxpayers should be aware of potential red flags and adhere to IRS guidelines to ensure compliance and minimize the risk of scrutiny.
