You may have heard horror stories about IRS audits of tax returns. The good news is that IRS audits only a very small percentage of returns filed. However, the likelihood of an audit increases if the return has any of these IRS “red flags.”
High-income earners. In 2015, 0.8 percent of all individual tax returns were audited, but among taxpayers with income of $1 million to $5 million, the audit rate jumped to 8.42 percent. Taxpayers with income of $10 million or more have about a one-in-three chance of hearing from a tax auditor.
Making or receiving alimony payments. Alimony payments are taxable income to the recipient and deductible by the payer, but divorced spouses sometimes fail to use the same numbers. For that reason, the IRS matches deductions taken by the payer to income reported by the recipient. Differences could mean one or both of the spouses are selected for an audit. See Alimony in the IRS Spotlight for more information.
Having an undisclosed foreign bank account. Taxpayers with balances in foreign accounts that total more than $10,000 during the year must file FinCEN Form 114, commonly referred to as an FBAR. International banks are now required to report U.S. account holdings to the IRS, so failure to file an FBAR could result in severe penalties and possibly an audit. For more information about the FBAR and its filing deadline, see Foreign Investments Require Extra Reporting.
Claiming big deductions. The IRS tracks statistical data, such as average charitable contributions at every income level and average amounts of other common deductions. Taxpayers who claim above-average deductions might be asked to provide receipts to substantiate those amounts.
Business or hobby. If you have a Schedule C in your tax return and it shows a loss, be prepared for a review. The IRS knows many “businesses” are actually hobbies because they lack a profit motive. Be prepared if this describes one of your business activities.
If you fall into one of these red flag categories, you can prepare for a potential audit by maintaining proper documentation. If the IRS contacts you about an audit, don’t panic. Give us a call – we’re here to help.
To learn more about year-round tax planning, projections, and preparation, visit Tax Services and contact us to request a free thirty-minute appointment to discuss how we can help you.
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