Less than 1% of federal tax returns are audited, but you don’t want to be in that 1%. It could mean agents knocking on your door, but it will probably mean a mail audit. Still, you don’t want to get on the wrong side of Uncle Sam — that could lead to a major tax dispute or even litigation.
There are definitely red flags that the IRS looks for when determining who to audit, but most of those red flags are secret. What accountants and tax attorneys often do, however, is keep track of what sorts of things commonly result in audits so you can avoid them. Here are four common tax mistakes that frequently lead to audits, as identified by the money and investing group The Motley Fool:
Claiming a relatively huge deduction. If you earn $50,000 a year, it’s pretty unlikely that you paid out $25,000 in charitable contributions. If you’re claiming a substantial portion of your income in tax deductions, you had better be able to back them up.
There’s nothing wrong with large deductions, even with the standard deduction set quite high by the Tax Cuts and Jobs Act. If your behavior falls outside certain normal patterns, however, the IRS could become more interested in your return.
Claiming deductions with round numbers. Your deductions are supposed to represent real money spent on deductible items such as medical costs and business expenses. You generally shouldn’t round these numbers. Suppose you had a deduction of $10,157, but you only claimed $10,000 to make your numbers easier to add up. It’s not illegal to underestimate deductions, but if you do it throughout your return the IRS may flag it for follow up.
Not reporting some sources of income. Whenever you do work outside your normal occupation, you should include it in your taxes. If for no other reason, then because the party who paid you probably reported that payment to the IRS. It may seem harmless to leave out that $750 handyman job you took from an acquaintance, but what if that acquaintance sent in a 1099 form, which they’re required to do for jobs exceeding $600 in a single year? The IRS routinely compares 1099s to tax returns to make sure they match up.
People who work in the gig economy often underreport their income. People who make a large portion of their income in tips are also prone to underreport. You should be aware that the IRS is aware and will make a point of adding up all your 1099s.
Claiming unusual business expenses. This is an area where audits are common because it’s easy to misunderstand business expenses. For example, you might have every right to deduct part of the value of your home office as a business expense, but probably not all of it. Likewise, you can’t expect to deduct 100% of the use of your car as business expenses. The IRS will expect you to explain how you got to all your personal errands without using your car.
Business expenses must be reasonable and closely related to business. And, the rules have changed somewhat under the new tax law, so be sure to check with the IRS or your tax attorney before you claim anything surprising.
Nobody wants to be audited, but it’s not the end of the world if you are. If you receive a notice from the IRS challenging your tax return, don’t panic. At the same time, don’t put off responding because the deadlines can be strict. If you need help responding, contact an experienced tax lawyer.