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It’s nearly impossible to pinpoint exactly what will trigger an IRS audit since the agency tries its best to keep industry secrets under wraps. Nevertheless, there are a number of signs which are known to be, across the board, massive red flags for an investigation.
The three basic types of IRS inquiries are matching, examination, and finally audits. Most of us are well aware of what an audit is, but what about the other two?
The IRS database uses copies of your 1099s and W-2 forms to match the income noted on your return. If an error has surface don your 1099 showing the wrong amount, then it’s your responsibility (and no one else’s) to have the issuer redo the paperwork with the factual information. An examination is just that—the IRS needs additional personal information to authorize a claim/deduction.
Disproportionate Donations
The IRS keeps a careful eye on the proportion of your income you give away in relation to nationwide averages for your income bracket. To put it simply, you’re not allowed to evade taxes by writing-off large philanthropic contributions. Likewise, you’re bound to raise eyebrows if you fail to submit Form 8283 for non cash donations exceeding $500. For that reason it’s crucial to file the proper paperwork and keep copies of all tax-related documents!
Rental Properties
In lieu of the recent economic downturn, the IRS has enacted a number of protocols to combat losses from passive real estate investors who offset their income using these “failed” investments. Since the early 90s, the number of real estate professional audits has risen significantly. To clarify, a “failed” investment is one that is either causing the investor the lose money in the short run because of high monthly expenses and depreciation or one that nets an overall loss at the time of liquidation. In order to legally write off losses, IRS regulations require you to spend more than fifty percent of your time or at least 750 hours each year in real estate related tasks.
Offshore Accounts
The term ‘offshore account’ may conjure up images from a James Bond or mobster flick in your mind, but to an IRS agent all it signals is tax evasion. Individuals with undisclosed foreign accounts face severe IRS penalties if they’re caught stashing away their bucks. The law states that any offshore account totaling more than 10k must be reported with FinCEN Form 114 and/or Form 8938.
Overinflated Income
The statistics suggest that only 1 in every 100 individuals gets IRS audited, however the odds change as your income bracket goes up. People earning $200,000 or more have an audit rate somewhere around 3.26 percent. That’s equivalent to about 1 in 30 tax returns. This isn’t in any way an attempt to discourage you from earning more, but just be aware that the IRS does take these factors into consideration.
“If your income has risen dramatically in the past year, or fallen dramatically, your return may be likely to trigger an audit, simply based on a computer scoring system called the Discriminate Function System, which rates potential for mistakes or dishonesty based on similar IRS returns,” says Lawrence Levy, CEO of Levy & Associates.
Writing-Off Vehicles
If you think you can sneak your “business vehicle” into your yearly write-offs, think again. Unlawfully declaring 100 percent business related use of your vehicle can be punishable by more than just a slap on the wrist. If you do decide to fully-claim the automobile, be sure to list the depreciation on Form 4562, keep timely records of all mileage, and related expenses. Heads up though—you can’t claim maintenance expenses plus insurance and other costs if you’re going by the IRS’ mileage rate.
Privately Owned or Small Businesses
Owners of small business—especially those that are cash based—are strongly advised to be honest in their declarations. Studies show that these types of business, on average, tend to declare much less than they actually take in. Remember honesty is the best policy when it comes to dealing with Uncle Sam because if he catches on to any misconduct, you’re guaranteed to be the winner at a losing game.
