- While the chances may seem slim, certain behaviors can increase your chances of being flagged by the IRS.
- The IRS pursues those who underreport their income, have excessive write-offs relative to their income, and claim deductions they don’t qualify for.
- The burden of proof is on the taxpayer, so it is important to keep good financial records to back up your tax return.
An IRS audit can be a nightmare.
Tax season has just ended, but it doesn’t mean you should wait another year before thinking about your tax situation. There are steps you should take now to set yourself up for success for next year. This can help prevent you from waiting until the last minute and making common mistakes that can trigger an audit.
In 2020, the IRS conducted almost 510,000 audits out of 157 million tax returns. According to the IRS, an audit is a review to ensure “information is reported correctly according to the tax laws and to verify the reported amount of tax is correct.”
While only a small percentage of tax returns get audited (0.3%), there are certain mistakes and behaviors that can put you on the IRS’s radar. Here are three common reasons your return may be flagged and what you can do now to prevent it.
1. You did not report the right income
The IRS has shifted audit resources and technology to focus on taxpayers that “have failed to file returns and those engaged in certain types of abusive transactions.” Per the IRS, its goal is to ensure everyone is paying what the law requires and do not purposely avoid their tax obligations.
The IRS receives copies of your W-2 and 1099 forms filed by your employer and other third parties. They use this information to verify your income on your tax return. Especially if you changed jobs, you want to account for all W-2 income. Third parties like your investment broker send a 1099 of your capital gains, dividend, and interest income to the IRS. If you have a side gig or are an independent contractor, don’t forget to include that income as well. The IRS uses an Automated Underreporter Program, to match taxpayer income and deductions submitted by third parties such as banks, brokerage firms, and other payers on W2 and 1099 forms against amounts reported on individual income tax returns.
The IRS aggressively pursues those who intentionally underreport their income. This also includes those who don’t file returns at all. Of the 510,000 audits conducted in 2020, the IRS identified more than $12.9 billion in additional taxes that needed to be paid. Keep track of all of your tax forms so you don’t forget to report all your income.
2. You have excessive write-offs and deductions
Another red flag for the IRS is when taxpayers try to claim too many deductions. The IRS gives each tax return a numeric score and screens the highest-scoring returns, selecting some for audit. The score is based on the amount of income reported and the deductions claimed. The higher the deductions and write-offs relative to income, the higher the score. For example, if your annual income is $50,000 but your tax return shows you donated $35,000 to charity, your return will most likely have a high score.
Another issue is taking deductions you don’t qualify for. According to the U.S. Treasury Department, 31% of all IRS audits in the last 10 years were due to the earned income tax credit. The IRS estimated that 23.5% or $16 billion of EITC payments were issued improperly in 2020. You should also double-check deductions that may be outside of your job’s classification. The IRS uses data from similar tax returns to develop occupational norms and for computer screening purposes.
3. You do not have the right paperwork and receipts
It is important to keep all the receipts and paperwork to back up your tax returns. One of the top reasons people get audited is missing or mismatched paperwork. This often happens when people rush and try to do their taxes at the last minute.
If you have legitimate business expenses and other deductions you qualify for, make sure you have the receipts and paperwork to back it up. This is especially important if you are self-employed. When claiming a home office, business meals, or vehicle expenses, keep track of the documentation since the burden of proof will be on you.
For example, business meals are now 100% deductible, but you have to document the purpose of the meal, who you were with, and the date. It is important to be meticulous in documenting the deductions you are entitled to. Per the IRS, you should keep your tax documents for at least three years, with some paperwork required to be kept for seven years.
The average taxpayer spends 13 hours preparing a tax return. This number can vary widely based on the complexity of your personal financial situation. But no matter your situation, double-check your work, avoid common tax mistakes, and if need be, work with a professional to help you avoid being audited.
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