There are more than 35 major ways to ensure an audit by the IRS! The article below points out six popular reasons the IRS may audit you.. Most taxpayers don’t realize that the IRS randomly selects a small number of returns, each year to be audited. The remaining audits are generated because tax returns catches the attention of the “IRS Computer” who reports the inconsistencies to an “IRS Human” who allows the computer to start the audit process. Yes, you are correct, the first thing the “IRS Computer” does is collect information necessary to include in an IRS Notice that is sent to you!
No one really knows what will trigger an audit by the IRS, which causes many taxpayers to live in fear. And that’s exactly what the agency wants.
“The IRS isn’t going to give you a list of all the things that will definitely trigger an audit. They want filers to file their taxes as honestly as possible,” says Laurie Ziegler, an enrolled agent and director of the National Association of Enrolled Agents.
She says the IRS audits less than 1% of all individual returns annually, and it’s important to know that a letter from the IRS doesn’t necessarily mean an audit is coming.
There are three types of IRS inquiries: matching, examination and the dreaded audit. “They might just need a certain document to verify an income claim — that’s a matching request. They are saying, ‘we received this information, but we don’t see it on your return.’”
An examination would occur when the agency just needs more information validating a deduction or claim.
While it remains unclear exactly what triggers an audit, tax experts say there are some common factors that can increase your chances of ending up in the hot seat.
You didn’t disclose all your taxable income. The IRS gets copies of W-2s and 1099s and knows a filer’s income, so make sure to report it all. “[The IRS] will work to match all reportable items to your return. Any mismatches can raise the red flag,” Ziegler says.
You’re claiming the Earned Income Credit. This credit is applied to low to moderate income filers and can be worth up to $6,044, making it one of the most fraudulently-claimed credits, according to Ziegler. “Because sometimes people get back more than they earn with this credit, the IRS pays extra close attention to returns claiming this return, especially if it’s based on self-employment income.”
Robert Zeigen, director at CBIZ MHM adds, “Any time the government is giving away free money they are going to look at that return very closely.”
You filed a Schedule C. Most self-employed filers fill out Schedule C to report how much money they made or lost in a business. “If there is a presence of this form that shows many years of business loss, the IRS is going to want to look at your so-called business to make sure ‘hobby’ isn’t a better label,” says Zeigen.
Filers must report any income earned from a hobby, but they can’t deduct losses. “The IRS likes to see a profit two out of five years to consider a business legit,” Ziegler says. “If you have a loss for five years, you can still say it’s a business, but you better be prepared to prove it with things like advertisements, promos and things like that.” She adds that filers who have a full-time job outside of the business for which they filed the Schedule C are going to have a harder time proving it’s not a hobby.
You were really charitable. According to Zeigen, the IRS is cracking down on charitable deductions and wants documentation proving donations higher than $250. “They want to see the canceled check and a receipt from the charity confirming they got it.”
He adds that non-cash donations, especially those higher than $500, will draw attention. “The IRS wants to make sure that what you donate was in good shape, not worthless stuff you were going to throw away anyway. If you donate anything in excess of $5,000 make sure you get an appraisal because it’s likely to be looked at.”
Car donors used to be able to write off the fair market value of car, but the IRS now only allows the donor’s claimed value of the gift and how the charity uses the vehicle to be claimed.
You have a very large home office. Because home offices used to be a major audit trigger, according to Zeigen, the IRS created a limited safe harbor that allows filers to take a deduction of $5 per square foot up to 300 square feet. “Those in excess of the simplified method may trigger more scrutiny.”
You mortgage deduction seems too big. Zeigen points out that the IRS knows each filer’s income and is able to calculate from that how much a typical mortgage should be. “If you are claiming a mortgage deduction that is above the average for your income, the IRS might do a double take.”
Ziegler adds that many homeowners wrongfully try to deduct their entire home equity lines of credit. “There are limits of how much interest can be deducted from a mortgage or refinancing,” she says. “It can’t be more than $100,000 unless it’s based on the original debt in the home.”