Tax season can be stressful. Filling out forms and gathering information can feel overwhelming, especially for first-time filers. There’s also the worry about getting audited by the IRS, which is increasing its audits on high-income taxpayers this year.
An audit is basically a check by the IRS to make sure your tax information is correct. Even if you’re not a high-income earner, your chances of getting audited are pretty low. In 2022, out of 165 million tax returns, only about 0.4% were audited.
Audits can happen randomly, but certain actions are more likely to raise red flags. The IRS uses a statistical formula to compare your returns with others’.
So, it’s important to avoid common tax mistakes to lower your chances of an audit.
Mistake 1. Incomplete Tax Returns Can Raise Red Flags
While there’s no single guarantee of an audit, incomplete returns are a common trigger for IRS inquiries. According to tax expert Jo Willetts, simply missing a form can raise a red flag, especially for those who file last minute.
This is particularly true when claiming credits like the child tax credit, which allows parents to claim up to $2,000 per qualifying child. To receive these benefits, you need to prove you’re eligible. If you didn’t claim the child tax credit last year but claim it for three children this year, especially if they’re not newborns, the IRS might send you a letter for clarification.
It’s important to remember that receiving an inquiry doesn’t necessarily mean you’ve made a mistake. For instance, if you recently had a child, the IRS might be working off your previous year’s information and require updates for the current year.
Mistake 2. Avoid Common Tax Filing Mistakes
Making even simple mistakes on your tax return can lead to delays and extra scrutiny from the IRS. Entering incorrect information, like your Social Security number or address, can slow down the processing of your return, even if it’s just a typo.
Filing electronically can help you avoid these errors. Electronic filing systems often pull in information from previous returns and allow you to directly upload your W-2s or 1099s. This reduces the risk of errors caused by manual data entry.
Another way to ensure accuracy is to use a professional tax preparer. They can help you avoid mistakes and ensure you get the maximum refund you’re entitled to.
Mistake 3. Be Careful When Claiming Business Deductions as a Self-Employed Individual
While self-employed individuals can deduct legitimate business expenses to reduce their tax burden, it’s crucial to ensure accuracy and proper documentation. Here are some key points to remember:
- Claiming the home office deduction: This deduction is only applicable if the space is used “exclusively and regularly” for business purposes, not for personal activities like working from the dining table.
- Documenting transportation expenses: Keep track of the mileage used for work purposes to claim the appropriate deduction. Deducting 100% of your personal vehicle’s cost can raise red flags with the IRS.
- Business meals: While 100% deductibility was allowed in 2021 and 2022, the current limit is back to 50%. To claim this deduction, you need documentation, including the names of people you met, the purpose of the meeting, the date, and receipts.
Remember, maintaining accurate records and documentation is essential when claiming business deductions to avoid potential issues with the IRS.
Mistake 4. Be Mindful of Your Business Deductions
Filing a tax return for your business can be complicated, especially when claiming deductions. The IRS uses computer systems to flag returns with unusual deductions, which could trigger further scrutiny.
Here are some red flags to be aware of:
- Excessive deductions: If your deductions, like travel expenses, are significantly higher than what others in your profession typically claim, the IRS might take a closer look.
- Consecutive business losses: Claiming a business loss for several years in a row could raise questions about the legitimacy of your business in the eyes of the IRS.
- Poor record keeping: Sloppy record keeping can lead to inaccurate or fabricated deductions, which would be disallowed during an audit.
- Claiming ineligible incentives or credits: Trying to claim benefits you don’t qualify for can also trigger an IRS red flag.
It’s important to remember that you are entitled to claim all the deductions you are legally eligible for. However, it’s crucial to be meticulous in keeping records and documenting your expenses to avoid any potential issues with the IRS.
Mistake 5. Be Mindful of Large Charitable Deductions
If you itemize your deductions, you can claim donations you’ve made to qualified charities. This can include cash donations, as well as the value of donated items like cars, clothes, and other property. However, the IRS keeps an eye out for donations that seem unusually large compared to your income.
Their computer system, called the Discriminant Information Function system, automatically scans tax returns for these inconsistencies. As tax advisor Eric Greene-Lewis points out, “If you claimed a charitable deduction that’s, like, half your income, it’s going to catch their eye.”
The IRS has limits on how much of your income you can deduct for charitable contributions. While some types of donations can go beyond this limit, doing so is likely to trigger a closer look from the IRS. So, it’s important to have all your paperwork in order if you make large charitable donations.
Mistake 6. You possess Undeclared Income
Did you know that most employers are required to report your earnings to the IRS? This is done through a form called a W-2 for employees and a 1099 for freelancers and contractors who earn more than $600. This means the IRS automatically receives information about your income, making it difficult to hide anything.
The IRS doesn’t just rely on employers, though. They also receive information from banks, investment firms, and even gambling establishments. This means they are aware of interest earned on savings accounts, investment income, stock trades, and even large wins from gambling. In short, the IRS has a comprehensive picture of your income from various sources, including inheritances and almost any other kind of income you might receive.
For example, if you forget to report capital gains from your cryptocurrency trades, it could raise a red flag and trigger an audit from the IRS. So, remember, the IRS is well-equipped to track your income, so it’s important to be honest and report everything accurately.
Mistake 7. Unreported Income Can Lead to Trouble
Even if you work in a cash business, like waiting tables or babysitting, failing to report all your income can have consequences. Experts warn that even seemingly unconnected events, like applying for a home loan, can raise red flags for the IRS.
For example, if you claim $20,000 in income on your tax return but report $80,000 in income when applying for a government-backed home loan, it will likely trigger an investigation. Additionally, if you don’t keep good records of your business income, you are more likely to underreport your earnings and risk an audit. This is because the IRS receives reports of your income from various sources, such as Form 1099s, and can easily compare these amounts to what you claim on your tax return.
Bottom Line
Finally, it’s important to remember that the IRS accepts tips from individuals who suspect tax fraud. With the potential to receive a reward of 15% to 30% of the collected taxes, someone you know might be incentivized to report you if they believe you are not reporting all your income.
Frequently Asked Questions
Ques. What does the IRS audit?
Ans. The IRS audits various aspects of tax returns, including income, deductions, credits, and compliance with tax laws and regulations.
Ques. Who gets audited by IRS the most?
Ans. Small business owners, self-employed individuals, high-income earners, and those claiming certain tax credits or deductions are more likely to be audited by the IRS.
Ques. How much is IRS tax in USA?
Ans. The IRS tax rates in the USA vary depending on your income level and filing status. They range from 10% to 37% for individuals as of the latest tax year.
Ques. What actions can reduce the chances of an IRS audit?
Ans. Maintaining accurate records, filing on time, avoiding excessive deductions or credits, and reporting all income can help reduce the likelihood of an IRS audit.
Ques. What will trigger an IRS audit?
Ans. Red flags that may trigger an IRS audit include discrepancies in reported income, large deductions compared to income, inconsistent information, and certain industries prone to tax evasion.
Ques. What not to say in an IRS audit?
Ans. Avoid making false statements, volunteering unnecessary information, or providing incomplete records during an IRS audit. It’s crucial to be honest and transparent while avoiding speculation.
Ques. What is the most common type of IRS audit?
Ans. The most common type of IRS audit is the correspondence audit, where the IRS requests additional information or clarification through mail.
Ques. How do I solve an IRS audit?
Ans. Respond promptly and thoroughly to all IRS inquiries, provide requested documentation, and seek professional assistance from a qualified CPA or tax advisor if needed.
Ques. Which of the following is a tax avoidance strategy?
Ans. Tax avoidance strategies involve legally minimizing tax liabilities through methods like deductions, credits, and tax planning, as opposed to tax evasion, which is illegal.
Ques. What type of business gets audited the most?
Ans. Small businesses, especially sole proprietorships and partnerships, are more likely to be audited by the IRS due to the complexity of their tax returns and potential for underreporting income or overclaiming deductions.
Ques. Does Topic 152 mean audit?
Ans. No, Topic 152 on the IRS website typically refers to the processing of tax refunds and does not indicate an audit.
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