No one wants to face an IRS tax audit, but even if you do everything according to the rules, you could be subject to one. But, if you know the common reasons why the IRS might audit your income tax return, you might be able to avoid one.
The good news is the IRS audits less than 1 percent of all individuals, according to the 2015 Internal Revenue Service Data Book. That said, it’s entirely possible you might be part of that 1 percent.
The IRS uses a combination of factors to decide which tax returns to audit, said Michael Raanan, MBA, EA, owner of Landmark Tax Group and former IRS agent. “Many of these can be avoided on behalf of the taxpayer, while others are unavoidable,” he said.
Here are eight reasons the taxman might decide to pay you a visit. Pay attention and do what you can to prevent the IRS from auditing you.
1. High Income
The more you earn, the more the IRS is interested in you. For instance, the IRS audits 2.61 percent of returns filed by people who make at least $200,000. For those with incomes of more than $1 million, that number jumps to almost 10 percent.
2. Math Errors
You might think a little error wouldn’t draw attention. The opposite is true. “Mathematical errors are one of the most common mistakes on IRS returns, whether the return is filed on paper or electronically,” said Raanan. In 2015, taxpayers were notified regarding 2.2 million math errors, almost half of which were associated with calculating the amount of tax or number of exemptions, according to the IRS.
3. Unreported Taxable Income
Make sure you get proof of income from all third parties. When you have more than one employer — or client, if you’re an independent contractor — each must provide you with your income and deductions information. It’s crucial that you report all of your income on your tax return.
“Filers who don’t report all of their taxable income are more likely to face an audit,” said Andrew Oswalt, CPA and tax analyst for the tax preparation software company TaxAct. “The IRS gets copies of W-2s and 1099s. If there is a discrepancy between what the filer reports and what the IRS sees on his forms, the agency will take a closer look.”
4. Business Expenses
If you’re an entrepreneur or small business owner the IRS likely has you in its crosshairs. The IRS pays extra attention to those who file Schedule Cs because self-employed filers tend to claim too many deductions and often don’t disclose their full income, said Raanan.
Be careful if you claim your car as a business expense. “If you depreciate your car using Form 4562 you’ll be asked how much of its use was tied to business,” said Oswalt. “Most people use their cars for at least some personal things. If you tell the IRS you used your vehicle 100 percent of the time for business, it’s a red flag.”
5. Home Office Deduction
Many business owners work from home instead of spending money on an office. Claiming your home as an office could trigger an issue with the IRS.
“The business use of home deduction is a pretty common red flag for IRS agents,” said Oswalt. “If you want to take this deduction, make sure you use your designated home space only for business.”
6. Charitable Deductions
The IRS encourages people to donate things like money, clothes, food and even old automobiles to charities by offering a tax deduction for donations. But excessive donation amounts could draw the IRS’s attention.
“For example, claiming that you made more than $10,000 in donations to various charities with an income of $40,000 might be a red flag,” said Raanan. Make sure you’re honest about your charitable giving, follow the tax laws and you likely won’t have a problem.
7. Earned Income Tax Credit
Eligible workers with low to moderate incomes can take the Earned Income Tax Credit. If you’re qualified to take it, be careful when you figure out the numbers. In 2015 more than 10 percent of math errors on individual tax returns were attributed to the EITC deduction, according to the IRS.
Taking the EITC might be an IRS audit trigger for other reasons, too. “Recently, the IRS has announced that those who claim the Earned Income Tax Credit are more likely to be the subject of a tax audit, as there has been an increase in the number of frivolous claims,” said Raanan.
8. Gambling Winnings
Gambling income includes winnings from lotteries, raffles, horse races and casinos. You must report all income you receive from gambling on your income tax return.
“Failure to report even recreational earnings from gambling can catch the attention of the IRS,” said Raanan. “Only professional gamblers can deduct the cost of meals, lodging and other such expenses.”
How to Prevent a Tax Audit
“It pays to have someone review and double-check your facts and figures before submitting your tax return to the IRS,” said Raanan. “You don’t want a slight oversight like an incorrect Social Security number or a misplaced decimal to prompt an audit.”
You’ll fare much better during an audit if you’re well organized. “The key for every taxpayer is to keep good, detailed financial records,” said Oswalt. “A good rule of thumb is to keep all tax-related documents for three years from the date a return is filed.”
Getting audited doesn’t always spell disaster. In 2015, more than $1 billion was returned to audited individuals as additional refunds, according to the IRS. Should you get tapped for an audit, you might be one of those individuals this year.