Although the chances of taxpayers being audited have declined in recent years, with taxes becoming more complicated every year, there is always the possibility that a tax mistake turns into an IRS tax audit. Avoiding "red flags" like the ones listed below could help.
Claiming Business Losses Year After Year
When you operate a business and file Schedule C, the IRS assumes you operate that business to make a profit. Claiming losses year after year without any profit raises a red flag with the IRS.
Failing to Report Income from Form 1099
Resist the temptation to underreport your income if you are self-employed or have a second job. The IRS receives the same 1099 forms that you do, and even if you didn't receive a Form 1099 when you think you should have, you can't be sure the IRS didn't either. If the IRS finds a mismatch, you will hear about it.
Early Withdrawals From a Retirement Account
Generally, if you withdraw money from a retirement account before age 59 1/2, you will need to pay a 10 percent penalty. You will also owe income tax on the amount withdrawn unless you qualify for an exception. Sometimes - but not always - these types of early withdrawals trigger an audit, typically a correspondence audit where the IRS sends you a letter.
Excessive Business Expense Deductions
Too many deductions for your income and type of business, claiming 100 percent use of a car for business, and inflating business meals, travel, and entertainment expenses are examples of excessive business expenses that could raise a red flag. Always save receipts and document your mileage and expenses.
Failing to Report Winnings or Claiming Big Gambling Losses
Professional gamblers report winnings/losses on Schedule C, Profit or Loss from Business (Sole Proprietorship). They can also deduct costs related to their professions, such as lodging and meals. Gambling winnings are reported on Form W-2G, which is sent to the IRS. As such, you must report this income. You may deduct gambling losses, but you must itemize your deductions on Schedule A (Form 1040) and keep a record of your winnings and losses. Ordinary taxpayers (recreational gamblers) report income/losses as "Other Income" on Schedule 1 of their Form 1040 tax return.
What To Do if You Are Audited
If you've received correspondence from the IRS in the U.S. mail that indicates that you are being audited, don't try to handle it yourself. Instead, contact our team immediately for assistance as we partner with certified tax professionals.
Taxpayers who have been audited or otherwise interacted with the IRS should know that they have the right to know when the IRS has finished the audit. The right to finality is one of ten basic taxpayer rights - known collectively as the Taxpayer Bill of Rights. All taxpayers dealing with the IRS are entitled to these rights.
This blog is meant for educational purposes only. Articles contain general information about accounting and tax matters and is not tax advise and should not be treated as such. Do not rely on information from this website as an alternative to seeking assistance from a certified tax professional. Perlinger Consulting partners with certified tax professionals to assist our clients.