Tax Audit Awareness for 2019

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The end of tax season makes many of us jittery about the possibility of being the subject of an IRS tax audit, especially with so many changes brought on by recent tax reforms.

One way to allay these fears is by reminding yourself that the IRS performs audits on fewer than 1 percent of individual tax returns. For good measure, you can also try to avoid some of the items that might raise a red flag for an audit.

A complicated return is more likely to be audited than a simple return. Filing additional schedules to report business income and losses also may attract the attention of auditors. According to Joy Taylor, editor of the Kiplinger Tax Letter, special scrutiny is given to the returns of self-employed taxpayers in cash-heavy businesses such as hair salons, bars and restaurants.

Another self-employment red flag for audit is deducting a business loss for money spent on an activity that the IRS views as a hobby because it fails to generate a profit in three of five years reported. Filing Form 5213, which requests the IRS not audit the first five years of a business that is being transitioned from a hobby, can ironically attract the scrutiny of auditors.

Other complicated situations that put you at risk for audit include claiming an Earned Income Tax Credit, taking an alimony deduction or claiming losses from rental property. In fact, claiming a large number of deductions of any type in proportion to your income can be a red flag.

Income level is another factor that affects audit risk, with an “average” income decreasing the risk of an audit. IRS audit data for 2017 shows that taxpayers with a reported gross income less than $200,000 are audited only about 0.5 percent of the time, while those who report an income in excess of $10 million are audited almost 14.5 percent of the time. People who report no income at all have a 2.5 percent chance of being audited.

You may be audited if you don’t include all your W-2 and 1099 forms when you report your income, an obvious omission the IRS can spot quickly thanks to the fact that duplicate forms are filed with the IRS. Having money in foreign bank accounts that you fail to report can also lead to an audit and severe penalties.

Taking an early distribution from a retirement account such as a 401(k) or IRA before you reach retirement age can attract an auditor’s attention. Those who are younger than age 59½ can expect to pay an additional 10 percent in taxes as a penalty for early withdrawal. Many taxpayers who think they qualify for an exception to this penalty actually don’t, so the IRS pays attention to these withdrawals.

When it comes to deductions, claiming a larger-than-average total for charitable contributions compared to your income can be a red flag, as are big deductions for business travel and meals. Deductions for business entertainment, which were previously a red flag on many returns, are no longer allowed under new tax law.

Claiming a deduction for a business vehicle can still flag a return, since the IRS assumes that very few people will purchase a vehicle and use only for business purposes. Claiming a home office is another risky deduction, since the space can’t be used for anything else.

If you have earnings from gambling, whether you’re an amateur or professional, be sure to report it as income on your tax return. Since casinos are required to report winners, this is an area the IRS finds easy to check. Claiming large gambling losses when you haven’t report gambling income is a flag for auditors. Another type of gambling, day-trading in investment securities, could lead to an audit if you report losses on Schedule C but do not qualify as a securities trader under IRS rules.

With more states legalizing the sale of marijuana, owners of marijuana businesses could wind up with an audit and even more legal trouble if they try to deduct business losses. The federal government still categorizes marijuana as a controlled substance that is not legal for sale, so these deductions are not allowed.

Doing your taxes yourself is fine, but making basic math errors will unfortunately cause your return to receive closer IRS attention. If you don’t want to use the services of a professional tax preparer, a tax application such as Turbo Tax will help ensure your calculations are correct. Taxpayers with incomes lower than $66,000 can use the IRS Free File online software for no charge.
If you are unlucky enough to trigger an audit, there’s a good chance it will be conducted by mail rather than though face-to-face meetings with an IRS agent. In 2017, nearly 80 percent of audits were conducted entirely through correspondence. ■

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