IRS Audit Red Flags

Quick: What’s brown and really looks good on an IRS Agent? A Doberman. What do you call 25 IRS agents buried up to their chins in cement? Not enough cement. But seriously, folks – one of the questions I’m frequently asked is, “Will this [fill in the blank] be a red flag?” Maybe, maybe not, but there is no guarantee that you won’t find a letter from your friendly IRS center in your mailbox.

Some activities do have a higher chance of scrutiny, however. You might be interested to know, for example, that the most audited item on tax returns is a schedule C with a loss. Here are some common areas that may cause the IRS to take a second look at your return:

  • Taking higher-than-average deductions. These typically are returns with itemized deductions exceeding 40% of Adjusted Gross Income, particularly charitable contributions.
  • Unincorporated businesses (schedule C), especially if they are cash-intensive such as bars, car washes, and restaurants.
  • Unincorporated businesses with revenue greater than $100,000.
  • Filing a schedule C on your self-prepared return (same for filing your own partnership or corporate tax returns).
  • Unincorporated business losses in three out of five years (are you seeing a pattern here?)
  • Rental loss deductions, especially if you claim to be a real estate professional
  • Claiming a 100% deduction for a business automobile. The IRS also has an eye out for purchases of heavy cars with tax-favored depreciation, such as Hummers, particularly if the purchase is late in the year.
  • Failing to report foreign bank accounts – the IRS is highly sensitive to money held overseas in our post-9-11 world.
  • Math errors – if you aren’t using TurboTax or another computer program, triple check the math!
  • High income – you don’t have to be Donald Trump to be suspect. In 2015, people with incomes of $200,000 or more tripled their chances of being audited.
  • A mismatch of reported income. This includes gambling winnings, 1099 income, and any other payments that fall under the IRS form “matching” system.
  • Taking big deductions for travel, meals, and entertainment.
  • Using a tax preparer who is known to the IRS to have questionable practices (sloppiness and errors, problematic deductions, etc.)
  • Claiming a lot of dependents – true story: seven million children disappeared from tax returns in 1987, when the IRS began requiring filers to list Social Security numbers!

While these areas may mean the IRS takes a closer look at your return, you should not be intimidated into sacrificing a legitimate deduction or not turning a profitable hobby into a business. As Judge Learned Hand stated in 1934, “Anyone may so arrange his affairs that his taxes shall be as low as possible…”

While you don’t want to intentionally wave a red flag, you should never be intimidated into waving a white flag for a deduction to which you believe you are rightfully entitled. If you’re not sure, consult with an experienced professional.

Watch this video to find some ways you can reduce your chances of an audit.

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