When you file your tax return in the coming months, an audit is probably the last thing you want to deal with. Fortunately, the chances for an audit are very slim, and fewer than 1% of all tax returns end up getting audited.
However, there are some things the IRS is known to take a closer look at. Specifically, certain types and amounts of deductions can raise red flags and cause the IRS to take a closer look at your return. Here are three tips from our tax experts, so you'll know whether you're a bigger audit risk this year.
Dan Caplinger: Charitable deductions have gotten to be a hot topic at the IRS lately, with the government looking closely at write-offs to make sure they're legitimate. One of the focus areas at the IRS has been on non-cash contributions, and not following the newly established procedures could put you in danger of an audit.
Specifically, whenever you give something that's worth more than $500, you have to complete a special IRS form and substantiate the value of the gift. For gifts of more than $5,000, you'll typically have to get a qualified appraisal for any gift other than publicly traded securities for which a market price is available. The appraisal ensures that you claim only the proper amount for your deduction, and failing to do so will almost certainly invite IRS scrutiny.
The rules are even more onerous for vehicle donations. If the charity sells your vehicle, then it has to provide you with documentation of how much it received, and your deduction is limited to that amount even if the blue-book value of the vehicle was higher. Only if the charity actually uses your vehicle for its charitable purpose, such as in serving its target population or by giving the vehicle to those in need, can you use an outside assessment of its value for deduction purposes.
Giving to charity is admirable, but you need to protect yourself in order to claim tax benefits. Otherwise, you could get into a lot more trouble than you ever imagined.
Matt Frankel: One thing many taxpayers don't realize is that the IRS keeps track of the average deduction amounts in pretty much every category. If yours are significantly higher or lower than the average, it can be a big red flag.
For example, looking back at Dan's discussion of charitable contributions, the IRS knows what the average taxpayer contributes in a year. According to data from the IRS's Statistics of Income, taxpayers with adjusted gross incomes between $100,000 and $200,000 donate about 2.6% of their AGI to charities and other nonprofits.
So, if your AGI was $120,000, the IRS expects to see about $3,100 in contributions. Slightly more than this amount probably wouldn't raise any eyebrows, but if someone of this income level claims $25,000 in charitable deductions, it's likely to get a closer look.
The same can be said for other deductions, such as medical expenses, state taxes, business expenses, and any other major tax break.
Having said that, if you did donate a big item (like a car) to charity this year, or had huge medical bills, by all means claim every penny of deductions to which you are entitled. Just make sure you can back it up if asked, and you should be just fine.
Selena Maranjian: Getting a tax return audited by the IRS could happen to any of us, but there are some things on our returns that the IRS sees as red flags and which could up our chances of getting audited. A bunch of these are business-related.
For example, simply being self-employed and filing Schedule C can raise the IRS's interest, because compared with a traditional wage earner employed by a company that reports compensation to the IRS, a self-employed person does a lot of self-reporting and has a greater ability to understate income and overstate deductions. If you're self-employed, for example, and take outsized deductions for meals and entertainment, the IRS might want to see receipts and might want to be convinced that they're truly business-related. Big deductions like that draw extra attention if your business isn't bringing in much money.
If you take a home-office deduction, deducting a percentage of your rent or mortgage interest, utilities, insurance, and real estate taxes from your business income, that's also a possible red flag. The IRS might ask to be assured that you're following the rules and truly using the room solely as a home office, and not just paying bills from a table in the corner of your den. Similarly, if you're claiming that you used your car, or one of your cars, 100% of the time for business, then that's a big red flag, as the IRS will doubt that. A smaller percentage is more realistic.
Fortunately, there's some good news: An audit isn't necessarily worth the worry, as long as you're not trying to cheat the government. If the IRS questions something you claimed on your return, you simply need to substantiate it by showing your detailed records. Thus, keep good records and you can worry less about audits.