IRS Audits and “Red Flags”
As tax attorneys, one of the most common questions we are asked is if someone will get audited. While this is an impossible question to answer, there are certain “red flags” that make an audit more likely. Some of these are situations you want to avoid because it also means your return may be incorrect. However, even if you have one of these situations, if your return is correct, you should not fear an audit.
Some of the common “red flags” for an audit:
- Not filing tax returns
- Claiming real estate losses normally only allowed for real estate professionals
- Failing to report all of your income
- Failing to report gambling winnings
- High Schedule C business expenses / small profit margin
- Using round numbers when reporting Income and expenses
- Claiming a high home office deduction
- Claiming high charitable donations
- Failing to report foreign bank accounts or assets
- Claiming a dependent who is also claimed on another return
The IRS receives reports from third parties, such as your employer reporting a W-2 or your bank reporting interest. Also, the IRS receives information on expenses such as mortgage interest paid every year. As you can see, many of these items involve information the IRS would have on file and that a computer could easily find as a mismatch. Another common tool the IRS will use is a cash analysis. This is where they look at income reported and compare that to what your actual living expenses would be to see if you may be underreporting your income.
As mentioned, filing and claiming high business expenses, high charitable deductions, or high home office deductions can be triggers for an audit, but if the numbers are accurate, you should not fear questioning from the IRS as long as you keep good records. However, if those expenses are round numbers that are more “estimates” than the actual numbers, then consider amending your return to claim the true expense items. It is oftentimes better to correct a mistake on a return than simply wait for the IRS to catch the mistake and start asking questions.
Now that the world is becoming more and more globalized, other countries are sharing information with the U.S. government and especially the IRS. If you have any foreign bank accounts, foreign companies or receive foreign income and are not claiming / reporting it on your U.S. tax return, it is imperative that you speak to an experienced tax professional. The IRS may know this information already and is simply waiting for you to file and report or it may receive the information sooner than later. The difference with international reporting is that it can also carry severe reporting penalties in addition to taxes.
You cannot avoid audits, especially since some are completely random. Nevertheless, you can make sure to prepare accurate returns, keep good records, and hire a qualified professional should you get audited so that you don’t have to worry.