The IRS strikes fear into the heart of many Americans due to their power to audit tax returns. In fact, according to a recent survey of 1,002 Americans by GOBankingRates, nearly 11% of respondents indicated that being audited was their greatest fear at tax time.
While the chance of being audited in any single year is actually quite low — reaching just 0.38% of all returns in 2022, for example — it is true that over a lifetime, your chance of being audited is higher than that. According to the same GOBankingRates survey, 18.5% of respondents indicated they had been audited at least once.
To lower your chances of being audited, it pays to know what the IRS considers red flags when it comes to your tax return. Here are some of the most common features that can trigger an IRS audit, along with suggestions on how to avoid them.
Failing To Report All of Your Income
Some taxpayers are unaware that the IRS gets a copy of every tax form that they do. For example, if you work at a job and have a savings account at a bank, you’ll receive a W-2 reporting all of your income and a 1099-INT showing the interest you received on your bank account — and so will the IRS.
If you fail to report all of your income, that’s an easy audit trigger. When you submit your tax return, one of the first things the IRS computers will do is match what you report on your return with the information it has about your earnings — and if those numbers don’t line up, you’ll almost certainly hear from the IRS.
Taking Outsized Deductions
One of the reasons those who run their own businesses are audited more frequently than wage-earning taxpayers is that there is a much bigger opportunity to abuse tax deductions. Business owners have access to a wide range of tax deductions not available to wage earners, from supplies and health insurance to business loan interest and internet costs.
As these deductions are self-reported, the IRS computes average norms for the size of deductions usually taken by various types of businesses. If you claim a much larger percentage of deductions relative to income than similar businesses, you could be in line for an examination of your return.
Erroneously Claiming Tax Credits
Tax credits directly reduce your tax liability on a dollar-for-dollar basis. Some are even refundable, meaning the IRS will actually pay you if your credits exceed the amount of the taxes you owe.
For this reason, the claiming of various tax credits often gets additional scrutiny from the IRS. While you shouldn’t fear claiming all of the tax credits that you are legitimately entitled to, just be sure that you can document your qualification for them before you file your tax return.
Writing Off Personal or Hobby Expenses as Business Losses
One of the biggest audit triggers is trying to write off personal expenses as a business loss. For example, if you write off all of your automobile expenses as business expenses, even when you use your car for personal reasons like taking the kids to school or going on road trips, it likely will catch the eye of the IRS.
The same is true if you try to write off personal expenses as company costs when they clearly don’t match your line of business — e.g., you deduct plane flights and hotels when you are a stay-at-home contractor.
The IRS also frequently disallows “hobby losses” that taxpayers try to use as legitimate business expenses. The IRS generally considers a “business” to be a hobby if it doesn’t generate a profit for at least three of the previous five years and if it is not run in a business-like manner.
Reporting — or Not Reporting — Foreign Bank Accounts
While it is not illegal for Americans to have foreign bank accounts, the IRS wants to know about them. This is to help cut down on money laundering and the sheltering of assets from taxation.
If you report a foreign bank account, particularly a sizable one, the IRS might start nosing around your return to try to track the origination of those assets. On the other side of the coin, if you fail to report a foreign bank account and the IRS gets word that you do indeed have one — as many countries report such data to the IRS — you can expect increased IRS attention as well.
Earning Too Much or Too Little
The statistics for the frequency of audits are telling. While the overall chance that your return may be audited is a scant 0.4%, those numbers jump dramatically for both the highest and lowest earners.
If you have no total positive income, for example, the chance your return is audited jumps to 1.1%. However, if you earn over $10 million, the audit rate balloons to 8.7%, per IRS data as of May 1, 2022.
Most people likely understand why higher earners get audited more frequently. At the most basic level, taxpayers with high incomes are low-hanging fruit for auditors, as there is generally more money available for recovery. Higher-income individuals also tend to have more complex tax returns and/or run their own businesses, which can offer them the opportunity to take larger tax deductions or shield more of their income.
On the other end of the spectrum, the lowest-income Americans get audited more frequently, generally due to their access to more tax credits. The Earned Income Tax Credit, in particular, is often claimed incorrectly, which can lead to an IRS audit.
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Methodology: GOBankingRates surveyed 1,002 Americans aged 18 and older from across the country on between January 30 and February 1, 2023, asking fourteen different questions: (1) How do you plan on filing your taxes for this year?; (2) When do you expect to file your taxes this year?; (3) How much do you expect to receive in a tax refund?; (4) What do you plan to do with your refund?; (5) Do you feel confident you are receiving all the deductions you feel qualified for?; (6) Do you believe your tax dollars are being spent effectively?; (7) Do you believe you are paying too much, too little, or a fair share in taxes?; (8) Have you ever been audited before?; (9) Who will/would use your tax dollars the best?; (10) How much is the standard deduction for a single filer (and married filers) in 2023?; (11) What concerns you the most about Tax Day?; (12) Do you expect your tax refund this year to be more or less than last year?; (13) What do you understand the least about your taxes?; and (14) What would you rather be doing than your taxes? (Select all that apply). GOBankingRates used PureSpectrum’s survey platform to conduct the poll.