Taxing Issues.. Key Triggers for an Audit

In Financial Planning, Tax Planning, Taxes by Landmark Financial Advisors, LLCLeave a Comment

IRS funding cuts have shrunk examinations to their lowest level since 2005. Only 1 return out of every 104 filed are examined, and we expect this number to get wider as funding continues to be an issue for the agency.  In addition, the agency continues to suffer brain drain as experienced examiners retire or leave for a better work environment.

It makes me wonder when Congress will address tax reform.  Our system is too complex, and cheaters are less likely to get caught as the agency suffers.  It’s a no brainer in my opinion to drastically simplify the tax code.

Of course, the only reason filers should worry about an audit is if they are fudging on their taxes, but the following are some of the key tax triggers that Kiplinger’s recently published:

  1. Making Too Much Money – Recent IRS statistics show that people with incomes of $200,000 or higher had an audit rate of 3.26%, or one out of every 30 returns. Report $1 million or more of income? There’s a one-in-nine chance your return will be audited.
  2. Failing to Report Taxable Income – IRS receives copies of all W2s and 1099s.  The computers will match these up, so error are sure to be caught.
  3. Taking Large Charitable Deductions – If your charitable deductions are disproportionately large compared with your income, it raises a red flag.
  4. Claiming Day Trading Losses on Schedule C – I will refrain from jumping on my soapbox! Losses of traders who make a special section 475(f) election are fully deductible and aren’t subject to the $3,000 cap on capital losses.
  5. Claiming Rental Losses – The IRS is actively scrutinizing rental real estate losses, especially those written off by taxpayers claiming to be real estate pros and whose W-2 forms or other businesses show lots of income.
  6. Deducting Business Meals, Travel and Entertainment – History shows that most underreporting of income and overstating of deductions are done by those who are self-employed. And the IRS looks at both higher-grossing sole proprietorship and smaller ones.
  7. Claiming 100% Business Use of a Vehicle – Claiming 100% business use of an automobile is red meat for IRS agents.
  8. Writing Off a Loss for a Hobby Activity – The law bans writing off losses from a hobby. For you to claim a loss, your activity must be entered into and conducted with the reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes that you’re in business to make a profit.
  9. Claiming the Home Office Deduction – The IRS is drawn to returns that claim home office write-offs because it has found great success knocking down the deduction and driving up the amount of tax collected for the government.
  10. Taking an Alimony Deduction – The divorce, separate maintenance decree or written separation agreement can’t say the payment isn’t alimony. And the payer’s liability for the payments must end when the former spouse dies.
  11. Running a Small Business – Small business owners in cash-intensive businesses—think taxis, car washes, bars, hair salons, restaurants and the like—are a tempting target for IRS auditors. Experience shows that those who receive primarily cash are less likely to accurately report all of their taxable income.
  12. Failing to Report a Foreign Bank Account – The IRS is intensely interested in people with money stashed outside the U.S.
  13. Engaging in Currency Transactions – The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious-activity reports from banks and disclosures of foreign accounts So if you make large cash purchases or deposits, be prepared for IRS scrutiny.
  14. Taking Higher Than Average Deductions

Read more details from Kiplinger at the IRS Audit Dirty Dozen Slide Show.

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