In our last post we discussed the IRS' special wealthy taxpayer audit team and the fact that wealthy California taxpayers are many times more likely to be the subject of an IRS audit. Although a taxpayer's income or wealth can make an IRS audit more likely, there are a variety of specific factors that may raise a "red flag" with the IRS and make an audit imminent.
Five things that may trigger an IRS audit include:
1. Investment losses
The IRS may becomes suspicious of investment losses claimed by California taxpayers involved in partnerships and Subchapter S corporations. The IRS will look to see if a taxpayer is using the losses to just offset otherwise taxable income. Specifically, the IRS will examine the nature of a secondary business to determine whether expenses incurred in the business are legitimate business expenses or hobby losses.
2. Home-loan interest deductions
Mortgage interest deductions over $70,000 may trigger an audit because deductions for mortgage interest are allowed for up to $1.1 million in debt for those who have first and second homes and a home-equity loan in a joint filing. A 6 percent interest rate on $1.1 million in debt is $66,000, so anything above $70,000 may appear suspicious.
3. Property Transfers
The IRS may seek to collect penalties and interest from California taxpayers that failed to file gift-tax returns. A gift-tax return must be filed for any gift valued above $13,000, which is the yearly gift-tax exclusion. Taxes have to be paid if the taxpayer has already exhausted his or her estate-tax exclusion.
4. Foreign Income
Unreported foreign income has been the focus of many IRS probes recently. Please see our coverage of offshore bank accounts for more information.
5. Big-time Spenders
The IRS has begun comparing California taxpayers' reported income with credit-card records. If there is a vast discrepancy, the IRS may ask for an explanation.
Source: Barron's, "How the IRS Is Probing the Rich," Karen Hube, Sept. 17, 2011