Typically, the IRS audits between 1% to 2% of tax returns each year. Most tax audits are for high-income earners exceeding $1 million a year. Although the chances of being audited are slim, new IRS funding may increase the odds of being audited going forward.
That said, we’ll review twelve triggers that often result in an IRS audit.
What Triggers an IRS Audit?
1. High-Income Earner
As mentioned earlier, a large percentage of returns audited by the IRS belong to high-income earners. These taxpayers usually make over $1 million a year. If your total income is below this amount, you can still be audited, but the odds are significantly lower.
2. Failure to Report Income
The IRS has copies of your W-2 forms and 1099s for reporting income. They’ll cross-reference income forms you submit with copies they receive to make sure all income is reported as required. If you fail to report your entire income, the IRS will flag your return for further scrutiny.
3. Failure to Report Cryptocurrency Transactions
If you had any cryptocurrency (whether you received, sold, or exchanged), you must report virtual currency transactions to the IRS on your tax return. Digital currency is taxed like any other type of property. Tax rules that apply to other traded assets, such as bonds and stocks, also apply to cryptocurrency. Consequently, expect to hear from the IRS when you fail to report crypto transactions.
4. Cash-Only Business
If you run a cash-only (or even cash-heavy) business, you are more likely to be audited. Over the years, the IRS has detected that many cash-only business owners intentionally don’t declare some cash income that should be reported. To curb this practice, the IRS has increased its efforts to audit the returns of cash businesses.
5. Excessive Deductions and Business Expenses
IRS small business tax deductions allow taxpayers who regularly work at home in an area dedicated to their business to deduct a portion of the cost of this space. Excessive deductions related to home office use, however, are more likely to result in an IRS audit. Also, claiming you use your car 100% of the time for business is likely to catch the eye of the IRS.
6. Several Years of Business Losses
If your business fails to realize a profit for several consecutive years, the IRS may flag your tax account to establish whether you are indeed running a real business. Reporting losses in more than two years out of five may lead to a business audit.
7. Missing or Incomplete Tax Returns
Failure to file or filing incomplete returns will automatically land you in trouble with the IRS. For example, you must file a tax return even if your business takes a loss. Similarly, filing incomplete returns will result in a tax audit even if all that is missing is just a signature. If you are inconsistent with filing your returns, the IRS will contact you for an explanation.
8. Math Errors
Filing tax returns with addition or subtraction errors often results in an audit. Note that the IRS flags returns with math errors even when the errors favor them.
9. Filing Schedule C When Self-Employed
Each year, many business owners include Schedule C to report income and losses on their 1040 tax return. This is especially common with sole proprietorships. Schedule C typically reveals the profit or loss of your entity but also increases the risk of your return being audited.
Unfortunately, there isn’t much you can do to avoid being audited when you file Schedule C. However, ensure you have all the appropriate documentation to support the money made or lost that you report.
10. Early Retirement Withdrawals
If you take early withdrawals from a tax-favored retirement account that doesn’t meet exceptions to be exempt from taxes, your return will likely be flagged. Such withdrawals usually result in an additional 10% penalty.
11. Large Charitable Donations
The IRS offers a tax deduction in exchange for a charitable donation. In these cases, the taxpayer has the freedom to determine the value of goods donated. As a general rule, IRS expects you to value the items you donate in the range of 1% to 30% of the original purchase price. If you don’t follow this guideline, too high of a value for your donations will increase your chances of being audited.
12. High Rental Property Expenses or Losses
Rental losses usually attract the attention of the IRS since they are considered unusual. The IRS will carefully review your tax return for any rental deductions made for depreciation. As an example, any attempt to deduct the total amount of improvement and renovation expenses in one year usually results in an audit. Under MACRS rules, such expenses should be spread over several years.
How Can Wiztax Help?
Most taxpayers are audited by the IRS because of simple, avoidable mistakes when filing their returns. If you received an IRS audit notice for any of the triggers above, Wiztax can help you correct the issue with the IRS. If you owe the IRS money, there are a number of tax debt relief programs that can help.
Call us today at (866) 568-4593 to learn more about how we can help with your IRS audit.
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