Avoiding a Tax Audit: 15 Red Flags to the IRS
by www.SixWise.com

The fear of being audited by the Internal Revenue Service (IRS) is enough to keep many Americans up at night, especially at this time of year when your tax return is fresh in your mind.

To put your mind at ease, your chances of being audited are actually pretty low. As written in The New York Times, “Only about 1.4 million of the 135 million returns filed each year are audited and of those, only about 310,000 taxpayers are forced to look an IRS agent in the eye and explain their numbers.”

Still, most of us would rather NOT be on that list of 1.4 million, and certainly would take great lengths to stay out of that 310,000. Truth be told, even if you DO end up getting audited, you have nothing to worry about as long as you were truthful on your tax return, and you have the paperwork to back it up.

Considering that 89 percent of Americans said it was unacceptable to cheat on their income taxes, according to the IRS Oversight Board’s 2008 Taxpayer Attitude Survey, this represents the majority of returns. As you might expect, even though the IRS only audits a small portion of returns they estimated that about 86 percent of taxes owed are collected, and a large portion of those that aren’t are due to mistakes.

Of course, there ARE those who try to beat the system and take one too many liberties with their deductions, or forget to claim all of their actual income. And anyone can make an honest mistake that could lead to their tax return being a bit off.

What adds to most people's fear of being audited is that of the unknown: Very few people know just how the IRS chooses which tax returns to audit.

The IRS, on the other hand, has studied this topic extensively, and knows what to look for when going over returns. Here are some signs that will put your tax return at the top of their "to audit" pile. So take notice of -- and by all means avoid if they're not legitimate -- these red flags that increase your chances of catching the tax examiner's eye.

15 Audit Red Flags

1. Higher incomes: If your income is more than $100,000, your chances of being audited increase dramatically.

2. High incomes compared to the previous year.

3. Unreported taxable income.

4. Income other than basic wages (contract payments, etc.): 57 percent of income from sole proprietors (plumbers, etc.) is underreported, according to a 2006 report conducted by the IRS’s National Research Program.

5. Mathematical errors.

6. Unusually large charitable donations, including non-cash charitable deductions

7. Home office deductions: Particular attention is given to returns that claim home businesses in addition to a salary income or excessively high deductions that don't match with the business (for instance, expensive business meals for a virtual administrative assistant.) You should also be careful with how you define your home office, as the room has to be used exclusively for business purposes.
   
8. Itemized deductions: If you don't have proof for it then don't take an itemized deduction.

9. Large business meal and entertainment deductions or excessive business auto use.

10. Low income with large business deductions: Did you report earning $40,000 and write off $30,000 in business expenses? Chances are a tax examiner will find your return warrants a closer look.

11. Hobby Losses: Filing a Schedule C to report income or loss from a sole proprietorship that is not really a business but a hobby is one of the highest risk moves you can make.

12. Offshore credit cards.

13. Large casualty losses: The rules for claiming a casualty loss are very specific, so be sure your loss qualifies before claiming it.

14. Having several dependents.

15. Tax returns that claim the earned income tax credit -- a break for those with low-incomes -- are also scrutinized more closely by the IRS. That's because its requirements are complex and many honest mistakes are made by those who think they qualify, along with those who intentionally try to increase the credit's payout.

This isn't to say that you should be afraid to make honest deductions on your tax return or shy away from credits for which you qualify in order to avoid the IRS. If you qualify for a deduction, by all means take it. Further, if you DO get a letter from the IRS, don’t panic. Receiving a letter, instead of a phone call, means your case is not a particularly high priority.

Plus, the most common reason why people receive letters from the IRS is human error, often for something as simple as forgetting to sign your return.

Recommended Reading

What to Do if You Can’t Pay Your Taxes

How to Get the Greatest Tax Advantages by Donating Money to Charity

Sources

NYTimes.com April 11, 2009

National Spending Journal April 8, 2009