9 Common IRS Tax Audit Triggers
The IRS has a bad reputation as an agency that seeks to squeeze more money out of taxpayers. But the truth is as long as you are reporting your income appropriately — taking only legitimate deductions and not doing anything shady — you’re unlikely to ever experience a tax audit on your personal or business taxes.
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The IRS tends to trigger audits within three years of filing your taxes, though some situations — particularly if something criminal is going on — can take place after three years, according to Wayne Bechtol, a senior tax accountant and board advisor with Fiona. Nonetheless, finance and tax experts recommend being aware of the following IRS audit triggers.
Dealing in Cryptocurrency Transactions
The popular rise of digital asset transactions involving bitcoin, NFTs and other cryptocurrencies could trigger an audit, even if you haven’t made any money. According to Bechtol, “Return filers should indicate through Form 1040 whether they have engaged in a digital asset transaction. IRS tracks such transactions using data analytics and AI.”
Mismatch in Returns Filed
If you think the IRS won’t notice a little discrepancy between what you report and the forms you receive, you’re mistaken. “The IRS receives a copy of all your income documents, including the W-2, Form 1099, K-1, and others,” Bechtol explained. “The amounts should match those included in your tax returns. A mismatch can invite an IRS tax audit.”
Claiming Hobbies as Businesses
You can write off business expenses but not those from hobbies, Bechtol warned. “The IRS can distinguish between hobby and business expenses because any profit from a business not shown in three out of five years constitutes a hobby. Therefore, deductions for hobby expenses are limited.”
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Excessive Deductions or Tax Credits
Claiming an excessive amount of deductions or tax credits can also raise suspicion and trigger an audit, said Sophia Jones, an Investment Analyst at PiggyBank. “It’s important to ensure that all deductions and credits claimed are accurately and legitimately reported.”
Claiming Recurrent Business Losses
Some businesses don’t generate a profit right away, including startups. However, too many years without a profit can attract the IRS’s attention, according to Carl Jensen, personal finance expert and founder of Compare Banks.
“If you intend to claim deficits for more than just one year in succession, be sure you have the evidence to indicate that your company has a route to profitability and is not a pastime masquerading as a genuine business.”
Making Significant Cash Transactions
If you run a business that deals in large amounts of cash, Jensen warned to “be mindful of how you handle larger payments.”
Food and beverage firms are the most likely to be penalized for this, since they tend to handle more cash, but the IRS needs to know where the cash came from, how you spent it and where it went. “Check that you’re finalizing your books appropriately in terms of revenue acknowledgment, sales, and social security taxes, obtaining the appropriate credits where appropriate, and keeping electronic records of transactions,” said Jensen.
Not Reporting Income From Side Hustles or Gig Work
Side hustles and gig work may be separate from your main salary, but they count as income, according to Miles Brooks, a director of tax strategy at CoinLedger. “The IRS requires taxpayers to report income from side jobs like selling products on Etsy. The tax authority demands that taxpayers should estimate the tax payments associated with gig work, including reporting self-employment taxes.”
Claiming Rent Expense for the Self-Employed
Another favorite audit trigger, according to CPA Wendy Barlin, is questioning a home office deduction when a professional also has rent expense on their corporation. “The law requires only a primary office be deducted as a home office deduction so when they also see rent expense, this will trigger a notice.”
Writing Off Excess Travel Expenses
Sometimes the line between business and leisure travel can blur, but be very careful about writing off anything that isn’t for business, Barlin warned. “In the last few years the IRS was aggressively targeting travel expenses as many business owners were going on beach vacations and deeming these deductible as ‘retreats.'”
In general, she recommends that taxpayers “be reasonable in their expenses as IRS law requires all business income tax deductible expenses to be ‘ordinary and necessary’ for the business.”
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