Potential Reasons for an IRS Audit
Tax season has been shown to be a time when people's blood pressure may significantly raise. However, when filing your taxes with the IRS, most returns are processed without examination. With that being said, there are a few mistakes that tax payers make that may increase the chances for an audit. Such as:
Overlooked Income: Employers are required to issue a W-2; a copy of this must also be submitted to the IRS. If a freelancer or contractor is paid more than $600, they will receive a 1099-MISC. If you have dividend income or interest, you will receive a 1099-INT or 1099-DIV, and the IRS will receive a copy of this as well. If you gamble and have a big win, you can expect to receive a W-2G, and yes, the IRS will receive a copy of this too. All of these forms will be entered into the DIF (the IRS's computer system - Discriminant Information Function), and if for some reason a form is expected and is not there, a red flag goes up.
Early Withdrawals from Retirement Accounts: These withdrawals are most often NOT nontaxable. These withdrawals can be subject up to an additional 10% penalty. If for some reason this goes unreported, the IRS will detect an early withdrawal and potentially issue an audit.
Earning Too Much or Too Little: The IRS doesn't issue audits for just anything; they need to be reasonably sure that the taxpayer may owe additionally. Generally, this means that if you make over a certain amount of money (typically $500,000), you have a greater chance of being audited.
According to recent IRS statistics, if you make between $25,000 to $200,000, you have the lowest chance of an audit.
Deductions: There are a few types of deductions that may trigger an IRS audit. These include:
- Home Office Deductions: These deductions need to be carefully monitored; as any deduction the IRS feels is out of place can open you up to an audit. While many of us worked from home during the pandemic, it is legal to claim a percentage of the related expenses. However, be aware of what is an appropriate amount to claim based on the actual percentage of space in your home set aside for business, as well as supplies used.
- Charitable Donations: These have seen an increase in regulations in recent years. Many charitable organizations (churches, service organizations, etc.) are now reporting specific donations, as well as naming the contributor. You are required to document any charitable contributions. The IRS also maintains data for typical donation trends. If they perceive your donations to be “outside” of these trends, you may be audited.
- Substantial Change in Income: If the IRS sees a substantial shift in your income, you will want to be prepared with proper paperwork to back up these changes. You will need to be able to fully explain this shift to the IRS.
Own a Cash Business: These businesses include bars, salons, taxi services, restaurants, car washes, and more. A red flag arises with these businesses if the IRS sees that your lifestyle verses what you claim don't add up. Be sure to claim the appropriate amount of income for your lifestyle when running a cash based business to avoid being audited.
Remember, these are just a few reasons the IRS can choose to have you audited. For a more comprehensive list of audit triggers, contact our team of Certified Public Accountants at Schumacher Sama, serving businesses and individuals in the Greater Milwaukee area for tax, payroll, and accounting needs - including audits. We're here to answer your questions and help with financial statements. Call us today!