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Nobody wants to face an IRS tax audit, but even if you do everything according to the rules, you could be subject to one. The good news is that the chances of being audited are very low. The IRS audits only around 0.2% of returns filed by taxpayers in the most common income ranges.
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In any case, it’s good to have a tax audit defense in place, but it’s even better to know why people do get audited so you can avoid any potential red flags for the IRS. Pay attention and do what you can to minimize your chances of being audited.
When the IRS notifies you of a tax audit, it means it will examine your tax return more closely and request additional documents related to it. The IRS uses a combination of factors to decide who gets audited, said Michael Raanan, MBA, enrolled agent , owner of Landmark Tax Group and former IRS agent. “Many of these can be avoided on behalf of the taxpayer, while others are unavoidable,” Raanan said. Here are some major reasons you could be subject to an IRS audit:
The IRS is most interested in the highest- and lowest-earning taxpayers. For example, for the 2021 tax year’s filed returns, the IRS audited only 0.2% of those with an adjusted gross income (AGI) between $25,000 and $500,000 .
However, taxpayers who reported no positive income had an audit rate of 0.8% — four times higher than the $25,000-to-$500,000 earners’. Taxpayers earning $1 to $25,000 were audited at twice the rate of those earning $25,000 to $500,000.
For people who made $500,000 to $1 million, the percentage of those audited rose to 0.3%. For incomes of $1 million to $5 million, the percentage doubled to 0.6% but was still lower than the rate for no-income taxpayers. If you earned between $5 million and $10 million the odds increased to 1%, a nd if you made $10 million or more the odds jumped to 2% .
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You might think a little error wouldn’t draw attention, but you’d be mistaken. “Mathematical errors are one of the most common mistakes on IRS returns, whether the return is filed on paper or electronically,” said Raanan.
Make sure you get proof of income from all third parties who paid you during the year. When you have more than one employer, each must provide you with a W-2 showing your income and deductions information. And while independent contractors must report all of their income, whether or not they’ve received a 1099 for it, clients who pay a contractor $600 or more must file — and provide the contractor with — a 1099.
It’s crucial that you accurately report all your income on your tax return as not reporting income is a major red flag.
“Filers who don’t report all of their taxable income are more likely to face an audit,” said Andrew Oswalt, CPA and tax analyst for the tax preparation software company TaxAct. “The IRS gets copies of W-2s and 1099s. If there is a discrepancy between what the filer reports and what the IRS sees on his forms, the agency will take a closer look.”
If you’re an entrepreneur or small-business owner, the IRS likely has you in its crosshairs. The IRS pays extra attention to those who file a Schedule C because self-employed filers tend to claim too many deductions and often don’t disclose their full income, said Raanan.
Be careful if you claim your car as a business expense. “If you depreciate your car using Form 4562 you’ll be asked how much of its use was tied to business,” said Oswalt. “Most people use their cars for at least some personal things. If you tell the IRS you used your vehicle 100% of the time for business, it’s a red flag.“
Many business owners work from home instead of spending money on an office, which might enable them to deduct expenses like depreciation and utilities — or, under the simplified method, a flat rate per square foot. To qualify for the home office claim, you must use your home office regularly and exclusively for business — and it must be the principal place of your business. Claiming your home as an office could trigger an issue with the IRS.
“The business-use-of-home deduction is a pretty common red flag for IRS agents,” said Oswalt. “If you want to take this deduction, make sure you use your designated home space only for business.”
The IRS encourages people to make charitable donations of things like money, clothes, food and even old automobiles by offering a tax deduction for donations. Although your deduction is legally capped at up to 60% of your adjusted gross income, excessive donation amounts could draw the IRS’ attention.
“For example, claiming that you made more than $10,000 in donations to various charities with an income of $40,000 might be a red flag,” said Raanan. Make sure you’re honest about your charitable giving and follow the tax laws and you likely won’t have a problem.
Eligible workers with low to moderate incomes can take the earned income tax credit. If you’re qualified to take it, be careful when you figure out the numbers.
Taking the EITC might be an IRS audit trigger for other reasons, too. “The IRS has announced that those who claim the earned income tax credit are more likely to be the subject of a tax audit, as there has been an increase in the number of frivolous claims,” said Raanan. In fact, taxpayers who claimed the earned income tax credit had an audit rate of 0.8% — four times higher than the audit rate for $25,000-to-$500,000 earners.
Gambling income includes winnings from lotteries, raffles, horse races and casinos. You must report all income you receive from gambling on your income tax return, even if you don’t receive a Form W-2G documenting your winnings.
“Failure to report even recreational earnings from gambling can catch the attention of the IRS,” said Raanan. “Only professional gamblers can deduct the cost of meals, lodging and other such expenses.”
You can take steps to reduce your chances of being audited. “It pays to have someone review and double-check your facts and figures before submitting your tax return to the IRS,” said Raanan. “You don’t want a slight oversight like an incorrect Social Security number or a misplaced decimal to prompt an audit.”
You’ll fare much better during an audit if you’re well-organized. “The key for every taxpayer is to keep good, detailed financial records,” said Oswalt. “A good rule of thumb is to keep all tax-related documents for three years from the date a return is filed.”
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Daria Uhlig and Joel Anderson contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: 8 Ways an IRS Audit is Triggered