If you’ve ever been audited by the IRS, then you know it’s no joke. The IRS (Internal Revenue Service) will not skip a beat in reviewing questionable tax returns, assessing penalties and fees for delayed payment, or garnishing your wages to cover an unpaid federal debt. There are certain tax return red flags that can lead the IRS to audit you.
You certainly should be true and honest with what you report to the IRS, but some things may look suspicious. I’m sharing 5 tax return red flags that can lead to an audit by the IRS. If the audit doesn’t go in your favor, repercussions will follow.
Tax Return Red Flags
#1 Simple Calculation Errors
Thanks to technology, a computer can easily detect a calculation error on any return. As you may, or may not know, if you work for a company, you receive a W-2 form. A copy of that W-2 is also sent to the IRS by your company. If you prepare your own tax return, and the calculations don’t match what is on the W-2 (or any other form), the IRS computer system will pick it up.
This will automatically alert the system that something is wrong or off. While this won’t always lead to an audit, depending on the severity of the calculation error, it certainly puts you in the pool for being reviewed. If you do file your tax returns on your own, run it through a tax software before filing anything.
#2 Failing to Report all Income
This probably sounds like a no-brainer, but sometimes it can happen without you knowing. If you earn any money doing odd jobs, in excess of $600, you should receive a 1099 form. Similar to W-2s, if you receive a 1099, then a copy was also sent to the IRS. If you fail to report income earned on a 1099, the IRS will know.
But what if you don’t receive a 1099 and you know you made more than $600 for a side job or service? Report the income anyways. The IRS will still allow you to report income without an actual 1099. You can also contact the company or person who paid you to inquire. 1099s are required to be sent by January 31st of the following tax year.
#3 Saying your Hobby is a Business
When you are first starting a side hustle or business, you may not have profits. Very likely, your expenses exceed any income you made. While you are still required to report this all to the IRS, there will come a time when the IRS will start questioning the “validity” of your business, if all you report is a loss.
Obviously, businesses aren’t always successful overnight. Because of this, the IRS usually doesn’t inquire or look to initiate an audit until three to five years of consecutive reported losses. If you aren’t sure if your hobby (that you make money from) is considered a business in the eyes of the IRS, read their nine factors to consider when determining.
#4 Taking Advantage of Certain Deductions
There are plenty of tax credits and deductions to take advantage of. Some deductions are very common, while others aren’t as popular. Regardless of the popularity, there are certain tax deductions that will raise red flags to the IRS.
For example, charitable donations. This is one of the most common deductions, and because of that, the IRS has access to statistical data that can pinpoint uncommon behavior. The IRS can see what is a normal charitable donation amount based on income level and location. If you are contributing a high amount of charitable donations for your income level, the IRS will notice.
Other deductions that can easily be taken advantage of and raise the eyebrows of the IRS are business use of your home and car. It is very difficult to prove that you use your car or home for business 100% of the time. If that is what you indicate on your tax return, it could push the IRS into the direction of auditing you.
While there is nothing wrong with claiming business use of your home and car, make sure you keep excellent documentation. As long as you can prove what you are reporting to the IRS, you are good to go if and when an audit comes your way.
#5 Hiring the Wrong Tax Preparer
Unfortunately, it’s possible that an audit is triggered by the tax preparer you use more so than what is found on your actual tax return. If the IRS audits one of the returns filed by the tax preparer you use and find significant problems, it could lead them to audit all returns filed by that tax preparer.
While you can’t control if your tax preparer gets audited because of another return, you can control which tax preparer or preparation company you decide to use. Make sure you are using a reputable CPA or licensed company. You also can’t go wrong with a company like TurboTax, assuming your financial situation isn’t too crazy. Read Which Tax Preparer is Right for You for some guidance on choosing the best option for you.
What to Do if You’re Audited
If you do end up being a lucky individual who gets audited, don’t panic. You will likely receive written correspondence asking for additional supporting documentation for one or more of your income or expenses. Reply as timely as possible, and if you need more time, make sure you ask for it.
Always be honest with your auditor, and if something appears to be too much out of your control or you can’t evidence what you need to, hire a tax professional. Audits happen all of the time, so remain calm, do the right thing, and act as timely as you can.
Related: 6 Life Events that Trigger Taxes
IRS audits are no fun, so make sure you don’t give them any reason to audit you! Steering clear of the tax return red flags listed above will help ensure you avoid an audit. Have you ever been audited by the IRS? If so, how did that process go for you? Post a comment below to share your thoughts, questions and experiences!
1 thought on “5 Tax Return Red Flags that Can Lead to an Audit”
Doing research on this topic definitely opened my eyes to how important it is to be as accurate as possible when filing your taxes! Sure sounds like an audit isn’t anything anyone wants to deal with!