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14 IRS Audit Red Flags By Joy Taylor
That said, your chances of being audited or otherwise hearing from the IRS increase with key factors, including your income level, the types of deductions or losses you claim, how you make your money and whether you own foreign assets. Math errors may draw IRS inquiry, but "they'll rarly lead to a full-blown exam. Although there's no sure way to avoid an IRS audit, these 14 red flags could increase your chances of unwanted attention from the IRS.
MAKING TOO MUCH MONEY
We're not saying you should try to make less money--everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you'll be hearing from the IRS.
FAILING TO REPORT ALL TAXABLE INCOME
Taking Large Charitable Deductions
That's because the IRS knows what the average charitable donation is for folks at your income level. Also, if you don't get an appraisal for donations of valuable property, or if you fail to file Form 8283 for donations over $500, you become an even bigger audit target. And if you've donated a conservation or façade easement to a charity, chances are good that you'll hear from the IRS. Be sure to properly document everything.
CLAIMING DAY-TRADING LOSSES ON SCHEDULE C
But to qualify as a trader, you must buy and sell securities frequently and look to make money on short-term swings in prices. And the trading activities must be continuous.
The IRS knows that many filers who report trading losses or expenses on Schedule C are actually investors, who profit mainly on long-term appreciation and dividends, hold their securities for longer periods and sell much less often than traders, and can only report their expenses as a miscellaneous itemized deduction on Schedule A, subject to an offset of 2% of adjusted gross income.
So it's pulling returns and checking to see that the taxpayer meets all of the rules to qualify as a bona fide trader.
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CLAIMING RENTAL LOSSES
The rules require you to spend more than 50% of their working hours and 750 or more hours each year materially participating in real estate as developers, brokers, landlords or the like to write off losses without limitation. Also, if you actively participate in the renting of your own property, you can deduct up to $25,000 of loss against your other income. But this $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000.
DEDUCTING BUSINESS MEALS, TRAVEL AND ENTERTAINMENT
Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don't satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.
CLAIMING 100% BUSINESS USE OF A VEHICLE
As a reminder, if you use the IRS' standard mileage rate, you can't also claim actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has seen such shenanigans and is on the lookout for more.
WRITING OFF A LOSS FOR A HOBBY ACTIVITY
CLAIMING THE HOME OFFICE DEDUCTION
If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs that are properly allocated to the home office. That's a great deal. And beginning with 2013 returns, you have a simplified option for claiming this deduction. The write-off can be based on a standard rate of $5 per square foot of space used for business, with a maximum deduction of $1,500.
To take advantage of this tax benefit, you must use the space exclusively and regularly as your principal place of business. "Exclusive use" means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night, or as a guest bedroom or children's playroom. Don't be afraid to take the home office deduction if you're entitled to it. Risk of audit should not keep you from taking legitimate deductions. If you have it and can prove it, then use it.
TAKING AN ALIMONY DEDUCTION
The rules on deducting alimony are complicated, and the IRS knows that some filers who claim this write-off don't always satisfy the requirements. It also wants to make sure that both the payer and the recipient properly reported alimony on their respective returns. A mismatch in reporting by ex-spouses will almost certainly trigger an audit. Alimony doesn't include child support or noncash property settlements.
RUNNING A SMALL BUSINESS
Other small businesses will also face extra audit heat, as the IRS shifts its focus away from auditing regular corporations. The agency thinks it can get more bang for its audit buck by examining S corporations, partnerships, limited liability companies and sole proprietorships. So it's spending more resources on training examiners about issues commonly encountered with pass-through firms.
FAILING TO REPORT A FOREIGN BANK ACCOUNT
Failure to report a foreign bank account can lead to severe penalties. Make sure that if you have any such accounts, you properly report them. This means electronically filing FinCEN Form 114 by June 30 to report foreign accounts that total more than $10,000 at any time during the previous year. And those with a lot more financial assets abroad may also have to attach IRS Form 8938 to their timely filed tax returns.
ENGAGING IN CURRENCY TRANSACTIONS
If deductions on your return are disproportionately large compared with your income, the IRS may pull your return for review. But if you have the proper documentation for your deduction, don't be afraid to claim it. There's no reason to ever pay the IRS more tax than you actually owe.
TAKING HIGHER-THAN-AVERAGE DEDUCTIONS
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Comment by clicking here. Joy Taylor is Assistant Editor o The Kiplinger Tax Letter.
All contents copyright 2013 |