In 2016, the IRS audited more than 1 million tax returns. This is just 0.49% of the 244 million tax returns filed that year. However, the probability of being audited by the IRS is not necessarily 0.49%, because certain financial decisions you make can greatly increase your likelihood of a tax audit. While some returns are randomly selected, others are purposefully selected because the system registers certain factors as red flags.
Let’s take a look at 4 of those red flags—and how you might avoid them.
1. Very Low (or Very High) Income Levels
Statistically, the highest percentage of audits comes from taxpayers at both ends of the income spectrum. For example, the IRS audited 3.25% of those who reported no adjusted gross income, and it audited 0.8% of those who reported between $1 and $25,000. While these are small percentages, the rate is 2-8 times greater than the audit rate for those who reported between $50,000 and $75,000, which is closer to the average U.S. income.
The audit rate begins to significantly increase with incomes of $200,000 or greater. The IRS audits more than 10% of those who report between $5,000,000 and $10,000,000, and it audits nearly 20% of those who report more than $10,000,000.
If you are at either end of the income spectrum, you will need to take much greater care to adhere to state and federal tax law in case of an audit.
2. Mistakes or Round Numbers
If you make a tax miscalculation or report a different taxable income than what your employer submitted, you may be audited. Likewise, a slew of round numbers (e.g. $25, $75, $500, etc.) may appear as though you are guessing or making up numbers.
The IRS will correct small errors, but anything more than minor miscalculations may get you into trouble.
3. Using Your Home or Car for Business
Claiming deductions for a home office or a vehicle you use for business purposes is, of course, 100% acceptable. However, if you are using your workspace or vehicle just as much (or more) for personal reasons, you may find yourself facing an audit. Take great care to track your business mileage, and read these instructions from the IRS to ensure your home office deductions comply fully with tax law.
4. Large Donations
If you make a charitable donation to an organization, but your income does not appear to support that donation, the IRS may interpret the donation as a red flag. Some people may make a large donation but then, in the same year, lose their job. This is an acceptable situation. But those who claim huge deductions for their philanthropy even though they report very little taxable income may find themselves in trouble.
Are You Facing an Audit?
An audit doesn’t necessarily mean you have done something wrong. In some cases, the IRS will not discover any issues, and your return will not need to change. Even if the IRS does find an error, you may simply need to change the return and pay more taxes (including interest and penalties, if applicable).
However, you might not agree with the IRS. In this case, you may need to file an appeal, enter into mediation, or even litigate your case. In the worst-scenario, the IRS may conclude that you committed tax evasion or another type of fraud.
No matter the situation, you will greatly benefit from the support of an experienced professional. At Buchalter & Pelphrey Attorneys At Law, our lawyers have assisted clients with audits, disputes, and other tax matters for more than 45 years. We can help you prepare your returns and comply with all tax laws in order to minimize your chances of an audit. If you are currently facing an audit, we can step in and represent your interests from beginning to end.