One of the bigger fears that people have is receiving a letter from the IRS which states that they are making a change to their tax return and they owe more taxes. And, there is interest and penalties to be paid as well. Well, if we know what the IRS typically targets in their audits and avoid these or substantiate these, we can rest easy. And, probably avoid the letter in the first place.
Here are 9 typical IRS audit items:
- Making a lot of money. The IRS figures that if your income is higher, there is more “opportunity” to collect more in taxes. However, if you report accurately, you can be at ease.
- Failing to report all of your income. Well, if you have unreported income, especially income reported to you on a W-2 or 1099, it is just a matter of time before the IRS discovers this. Also, if you have a mis-match between your income and lifestyle, such as high mortgage interest and real estate tax payments or charitable deductions with income that does not cover your expenses, the IRS will be very curious on where your income is coming from.
- Taking higher than average deductions. The IRS uses averages to determine a range for charitable giving, mortgage and tax deductions base on income. If you are above average, the IRS may want to learn more. By all means, take all deductions that you have coming, but be able to prove it, if necessary.
- Running a small business. The IRS views small businesses as having underreporting income due to “cash” sales and mixing personal with business expenses. Your best defense is to be organized, have separation between your personal and business accounts and up-to-date accounting records.
- Taking large charitable donations. See #3 above. Keep your donation statements so you can prove your deductions.
- Claiming rental losses. If you are claiming the Real Estate Professional designation, the IRS will examine whether you actually qualify for this designation by looking at other activity on your tax return. If you do not qualify, the IRS will disallow the extra tax deductions take on your return.
- Taking an alimony deduction. Not all payments made to a former spouse qualify for an alimony deduction. Further, not all divorce decrees correctly name alimony in the IRS context. So, someone could be paying what their decree states as alimony but which does not qualify to be deducted as alimony.
- Writing off a hobby loss. A hobby is an activity that is not entered into for profit reasons which a business has an objective of a profit. Note: a business does not have to have a profit to allow you to take business expenses.
- Deducting Business Meals, Travel and Entertainment. Big deductions in the meals, travel and entertainment category is a easy target for IRS agents. They are looking for you writing off your personal meals and calling them business expenses.
If you have any of these 9 tax deductions on your return, know that your likelihood of audit is higher than those without these deductions. It does not mean you should not take them, if they are substantiated.