The overall audit rate is about 1 in 119 returns but this increases drastically with increases in income.

The chance of audit for those making over $200,000 is 1 in 38 and for those making over a million, it’s 1 in 10.  This compares to 1 in 132 odds for an audit if you make under $200,000.

  1. So, the first way to increase your chance of audit is to make more money, though I think we would consider that a nice problem to have.
  2. Fail to report income and odds are very high that you will get caught.  The IRS receives copies of all 1099’s and W-2’s and their computers are pretty good at matching up what they have with what you report.  Any mismatch automatically generates a letter which is usually a bill.
  3. If you take higher than average deductions, your return could be flagged.  The IRS has algorithms which compare your reported deductions with others that have similar return characteristics, such as income, profession, etc.  Exceed certain thresholds and your return will be flagged for audit.  That being said, if you have proper documentation for a deduction, by all means report it.  You are entitled to it.
  4. If you run a small business, the IRS is very familiar with those who claim excess deductions.  Record keeping is often poor in small businesses and tax myths about allowed deductions are rampant.  Claiming expenses that are not legally deductible and not having proper records of deductions claimed allows the IRS to win a large percentage of audits.  Cash rich businesses, such as taxis, car washes, bars, hair salons, etc. are favorite targets.
  5. Taking large charitable deductions can also produce audits.  The IRS knows the average deduction for people at your income level, and as in item 3, their computers will pick the returns that exceed certain thresholds.  Fail to file Form 8283 for non-cash donations over $500 and you have become a bigger target.  Record keeping is key to surviving these audits.
  6. Rental real estate loss claims have been a successful target for the IRS, especially concerning those taxpayers who claim real estate professional status.  Most people don’t realize that rental losses are passive losses and can be deducted only against passive gains or when the property is disposed of.  There are exceptions if you actively manage the property or claim real estate professional status.  It is important that you can prove you qualify for one of these exceptions if you claim real estate rental losses.
  7. Take an alimony deduction?  Make sure your court documents say it is alimony and not something else, like child support or non-cash property settlements.  Also, make sure you show the recipient’s name and social security number on your return.  If you receive alimony, make sure you claim it.
  8. Deducting business meals, travel and entertainment can raise alarms if the amounts seem too high for the business or profession.  You must have records documenting the deduction amount, the place, the people attending and business purpose.  No records and you are toast.
  9. Failng to report a Foreign Bank account is a hot button right now at the IRS, especially with all the foreign tax shelters that have been exposed in recent years.
  10. Claim 100% business use for a vehicle?  This is red meat for the IRS.  They know it is extremely rare for a vehicle to be used 100% for business, especially if there is not another vehicle in the household.
  11. If you take an early payout from an IRA or 401(k) account and you are under age 59 1/2, you likely have to pay a penalty on that early distribution.  There are exceptions that can be claimed but make sure you qualify.  This is an easy one to catch as the IRS has copies of the 1099’s for the distribution and your birth date.  Make sure the distribution code on the 1099 reflects the exemption if you are claiming one.
  12. Finally, if you don’t report gambling winnings or claim big losses, prepare for the audit.  Most gambling winnings are reported to the IRS on Form W-2G by the casinos or other venues.  Claiming gambling losses is possible up to the amount of winnings but you must have records of those losses.  For professional gamblers, more deductions are allowed but a discussion of those rules is beyond the scope of this article.

Come see us here at Aurora Financial Services if you are unsure of your record keeping  We can help make sure you are prepared should you be audited, especially if you have a business.

If you are about to be audited, give us a call.  We can help you prepare for that as well.

Good luck.