Are you in Danger of an IRS Audit?
Approximately 1.5% of all taxpayers are audited every year. Despite this relatively small number, the IRS still causes many people to shake in their boots when contemplating the chance of an audit.
The odds are low that you would be picked for an IRS audit because the IRS does not have enough personnel and resources to examine every tax return.
Your chances of being audited are higher depending on income levels, profession, transactions and tax deductions. Here are some tips on high risk areas for audits, so you can ensure you are not on that list.
High-Risk Tax Audit Areas
High Income
Your chance of being audit rises as your income increases. Here are some red flags to the IRS:
You have large amounts of itemized deductions on your tax return that exceed IRS targets.
o You claim tax shelter investment losses on your tax return.
o You have complex investment or business expenses on your tax return.
o You own or work in a business which receives cash and/or tips in the ordinary course of business.
o Your business expenses are large in relation to your income on your tax return.
o You have rental expenses on your tax return.
o A prior IRS audit resulted in a tax deficiency.
o You have complex tax transactions without explanations on your tax return.
o You are a shareholder or partner in an audited partnership or corporation.
o You claim large cash contributions to charities in relation to your income on your tax return.
o An informant has given information to the IRS.
Don't let these factors influence how you file your tax return. You must report all income and take all your deductions to ensure you prepare your tax return accurately and completely.
Large Amounts of Itemized Tax Deductions
If your tax deductions exceed a target range set by the IRS, this will increase your chance of an audit. You should of course take the deductions that you are entitled to, but beware that if they exceed the averages for your income level, this will increase chances for an audit
High DIF
IRS computers compare all tax returns to the national Discriminate Information Function (DIF) system average. The IRS calculates the DIF score by using a closely-guarded formula.
Tax returns with the highest DIF scores are scrutinized by experienced IRS examining officers who determine which tax returns provide the best chance for collecting additional taxes, interest, and tax penalties.
Unreported Taxable Income
This is a very common red flag for an audit. If the IRS finds unreported taxable income by matching income from your tax return with information from banks and other financial institutions, this will increase the chance of an audit. You must ensure that you report all 1099 forms from bank savings accounts, mutual funds and others.
If you hold rental real estate or know someone who holds rental real estate - This is a must Read.
IRS has decided to target returns with rental real estate for audit in 2012.
Rental Income
The IRS recently released a report indicating their intent to perform more examinations of individual tax returns that report losses from rental real estate activity. The increased scrutiny was triggered by a 2008 report that found at least 53% of individual taxpayers with rental real estate activity for tax year 2001 misreported their rental real estate activity. The report appears to direct the IRS focus on those taxpayers claiming real estate professional status
Thus, similar to documenting expenses, documenting your time devoted to real estate related activities is extremely important given the IRS's intent to look more closely at real estate activities.
Other Areas for Critical Review
Self Employment (Schedule C Filers)
Self-employed people come under more scrutiny for an audit, because the IRS believes most under-reporting of taxable income and abuse of tax deductions occurs among those who are self employed. Unfortunately, these individuals are audited by the IRS far more frequently than employees collecting a salary.
The IRS publishes manuals to familiarize its auditors with about 100 different businesses, particularly ones that have a high number of self employed individuals. You can get copies of these guides to further learn how to protect yourself from an audit at:
Audit Guides or call the IRS Freedom of Information Act Reading Room at (202) 622-5164, or write Box 795, Ben Franklin Station, Washington, DC 20044.
Home Office Tax Deductions
Home office tax deductions have been targeted by the IRS. Since the tax rules for deducting home office expenses on your tax return are complicated, you should consult a tax expert, such as a CPA, to determine whether you qualify to deduct home office expenses on your tax return.
Unreported alimony
Not all all taxpayers report alimony receipts as taxable income. Therefore, the IRS now matches tax deductions for alimony payments by one former spouse with the taxable alimony income reported by the other.
Automobile Logs
This is a commonly audited item for business owners and real estate investors. It's important to keep good records of your mileage log. An easy way to do this is to show the date, beginning and ending odometer readings, the location, the business purpose, and the client.
Defend Yourself!
You are entitled to take every tax deduction that you qualify for and you should never be scared by the potential of an IRS tax audit. You must use common sense when making decisions about deductions and hire a qualified CPA to help you through the minefield of taxes
Watch my recent webinar on 'How to Keep More of your Money this Tax Season' HERE
The odds are low that you would be picked for an IRS audit because the IRS does not have enough personnel and resources to examine every tax return.
Your chances of being audited are higher depending on income levels, profession, transactions and tax deductions. Here are some tips on high risk areas for audits, so you can ensure you are not on that list.
High-Risk Tax Audit Areas
High Income
Your chance of being audit rises as your income increases. Here are some red flags to the IRS:
You have large amounts of itemized deductions on your tax return that exceed IRS targets.
o You claim tax shelter investment losses on your tax return.
o You have complex investment or business expenses on your tax return.
o You own or work in a business which receives cash and/or tips in the ordinary course of business.
o Your business expenses are large in relation to your income on your tax return.
o You have rental expenses on your tax return.
o A prior IRS audit resulted in a tax deficiency.
o You have complex tax transactions without explanations on your tax return.
o You are a shareholder or partner in an audited partnership or corporation.
o You claim large cash contributions to charities in relation to your income on your tax return.
o An informant has given information to the IRS.
Don't let these factors influence how you file your tax return. You must report all income and take all your deductions to ensure you prepare your tax return accurately and completely.
Large Amounts of Itemized Tax Deductions
If your tax deductions exceed a target range set by the IRS, this will increase your chance of an audit. You should of course take the deductions that you are entitled to, but beware that if they exceed the averages for your income level, this will increase chances for an audit
High DIF
IRS computers compare all tax returns to the national Discriminate Information Function (DIF) system average. The IRS calculates the DIF score by using a closely-guarded formula.
Tax returns with the highest DIF scores are scrutinized by experienced IRS examining officers who determine which tax returns provide the best chance for collecting additional taxes, interest, and tax penalties.
Unreported Taxable Income
This is a very common red flag for an audit. If the IRS finds unreported taxable income by matching income from your tax return with information from banks and other financial institutions, this will increase the chance of an audit. You must ensure that you report all 1099 forms from bank savings accounts, mutual funds and others.
If you hold rental real estate or know someone who holds rental real estate - This is a must Read.
IRS has decided to target returns with rental real estate for audit in 2012.
Rental Income
The IRS recently released a report indicating their intent to perform more examinations of individual tax returns that report losses from rental real estate activity. The increased scrutiny was triggered by a 2008 report that found at least 53% of individual taxpayers with rental real estate activity for tax year 2001 misreported their rental real estate activity. The report appears to direct the IRS focus on those taxpayers claiming real estate professional status
Thus, similar to documenting expenses, documenting your time devoted to real estate related activities is extremely important given the IRS's intent to look more closely at real estate activities.
Other Areas for Critical Review
Self Employment (Schedule C Filers)
Self-employed people come under more scrutiny for an audit, because the IRS believes most under-reporting of taxable income and abuse of tax deductions occurs among those who are self employed. Unfortunately, these individuals are audited by the IRS far more frequently than employees collecting a salary.
The IRS publishes manuals to familiarize its auditors with about 100 different businesses, particularly ones that have a high number of self employed individuals. You can get copies of these guides to further learn how to protect yourself from an audit at:
Audit Guides or call the IRS Freedom of Information Act Reading Room at (202) 622-5164, or write Box 795, Ben Franklin Station, Washington, DC 20044.
Home Office Tax Deductions
Home office tax deductions have been targeted by the IRS. Since the tax rules for deducting home office expenses on your tax return are complicated, you should consult a tax expert, such as a CPA, to determine whether you qualify to deduct home office expenses on your tax return.
Unreported alimony
Not all all taxpayers report alimony receipts as taxable income. Therefore, the IRS now matches tax deductions for alimony payments by one former spouse with the taxable alimony income reported by the other.
Automobile Logs
This is a commonly audited item for business owners and real estate investors. It's important to keep good records of your mileage log. An easy way to do this is to show the date, beginning and ending odometer readings, the location, the business purpose, and the client.
Defend Yourself!
You are entitled to take every tax deduction that you qualify for and you should never be scared by the potential of an IRS tax audit. You must use common sense when making decisions about deductions and hire a qualified CPA to help you through the minefield of taxes
Watch my recent webinar on 'How to Keep More of your Money this Tax Season' HERE
Comments (4)
Bryan, my CPA just told me this week they are stepping it up on real estate investors like Ebere is saying.
Jon Klaus, almost 13 years ago
My CPA told me that they are beefing up what they can do now that many things are filed electronically. The government is going to look for money any way they can I guess.
Bryan Hancock, almost 13 years ago
In recent audits that I have gone through with clients, it's amazing how much the auditors do not know when it comes to the tax laws. So my conclusion is that they use scare tactics to make innocent citizens especlally real estate investors give in. How does an auditor think that the sale of a rental property is a capital loss? i was blown for like two days on that. Or how does a real estate auditor think that The cost basis of a property should not increase by the loan for which the investor is 100% liable. Bottom line, get a backbone when dealing with the IRS or get a CPA who is not afraid of the IRS. And the tax impact we are talking about is not pennies.
, almost 13 years ago
Thanks for the list of risk areas. I think it was Napoleon Hill who said, "the thing that we fear the most never happens." Or a corollary for an IRS audit, " If we are prepared, we need not fear."
Jon Klaus, almost 13 years ago