IRS Audit Triggers of Personal Income Tax Returns
Written by: Steven J. Fromm, J.D., LL.M. (Taxation)
The chances of being audited by the IRS depends on a whole host of factors. Some audit triggers, such as having a high amount of income or having a large family that results in a large amount of dependency exemptions, cannot be controlled. But, certain actions and tax positions taken on income tax returns are within the taxpayer's control and can either raise or lower the chances of being audited by the IRS.
The following are not an all inclusive list of factors but they are ones that usually raise the chance of being audited by the IRS:
Failing to report all income
Failing to report all income that is shown on tax reporting forms such as Form W-2s, Form 1099s for reporting dividends, interest and capital transactions.
Mismatching Of Information Returns
Related to the previous item, if information on your return doesn't match up with information on your Form 1099s or W-2s and Schedule K-1s the chances of being audited may increase. If these information returns are incorrect go back to the source and seek an amended informational return. Do not merely take a different position on your return if you do not agree with the numbers on these informational returns.
You are primarily a cash-income earner. This would be working in a profession that is traditionally a cash-income business such as a waitress or card dealer at a casino.
High Income Taxpayer
If you are a higher-income taxpayer there is little you can do about that, but knowing you are more audit prone can and should influence the positions and deductions you take on your income tax returns.
If you have a history of being audited, this should influence how you file your return.
If you are a partner or shareholder of a corporation that is being audited expect to be audited individually.
When you are self-employed or you are a business or profession currently on the IRS's "hit list" for being targeted for audit, such as Schedule C (Form 1040) filers), then you need to take responsible and perhaps conservative positions on your return.
If you report rental property losses, then your chances of audit increase.
Claiming the home office deduction. This may be a legitimate expense but realize the IRS forms have a block to check and a special form to file with the return when claiming such expenses and this usually triggers a review.
Questionable Business Deductions
Be careful in claiming business expenses. Taxpayers do not realize the level of scrutiny and documentation required if they are audited. Get your documentation in order while completing the return in question to make sure the deductions are justified and verifiable.
Travel and Entertainment
Claiming large deductions for business meals, travel and entertainment needs to be carefully reviewed and justified. If audited, IRS agents really sink their teeth into this area. Documentation and support of all expenditures are required. Amounts claimed on the return must tie in to supportable and legitimate expenses.
Automobile Claimed At 100% or a Very High Percentage of Business Usage
Reporting a 100% or a very high business use allocation for auto usage raises the chances of an audit.
Commuting expenses are not deductible so it is rare when a taxpayer can justify a 100% deduction for automobile usage.
Claiming a large hobby loss deduction can be especially problematic. These hobby loss rules are very detailed and IRS regulations and guidance have a very lengthy list of factors that are looked to in determining hobby loss issue.
It is important to point out that many of these cases end up in the United States Tax Court. Predicting a successful outcome in these situations is very difficult and the cost to litigate can be quite onerous.
Large Itemized Deductions
If you claim a large amount of itemized deductions or an unusually large amount of deductions or losses in relation to your income, you may trigger an audit.
Claiming large charitable contributions as an itemized deduction often brings increased attention to the return.
If you claim tax shelter investment losses expect to be audited. The IRS takes a dim view on these ventures.
First Time Home Buyer Credit
Claiming a first time home buyer credit has been abused by many undeserving taxpayers. The law allows for this credit but because of widespread abuse the IRS is checking such credit claims very closely.
Earned Income Tax Credit
You claim the earned income tax credit. Once again taxpayers have abused this area, so the IRS looks closer here to make sure the credit is justified.
If an informant has contacted the IRS asserting you haven't complied with the tax laws, you may have not only income tax problems but you may be subject to some severe penalties including criminal and civil fraud penalties.
Taxpayer Strategy To Protect and Counteract IRS Challenge
If any of these situations apply to you it would be prudent to have experienced tax counsel to assist you. Professional tax expertise, experience, insight and judgment can provide vital guidance to minimize tax liability exposure.
The only way to justify taking these positions or to combat these challenges is to have significant and sufficient documentation and records supporting such claims. In certain cases, it may be a good idea to attach support for for certain tax positions with the return filing if the taxpayer anticipates there may be an IRS challenge. Although such documentation may not stop an audit, it may provide sufficient and compelling support to enable the IRS to allow such deductions or credits.
Whether to take a given position or a deduction on a tax return or to give details and support on a tax return are tax strategies that should be discussed and explored with your tax attorney or tax accountant preparer before filing any return. Do not hesitate to contact our office if you need assistance.
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