This tax season, as the IRS begins to deploy its almost $80 billion in cash, there has been increased worry about IRS audits.
While the IRS intends to add more employees, including enforcement officers, experts say there is no need to be concerned as long as adequate documentation is maintained.
What is a Tax Audit?
A tax audit is an inspection or review of a taxpayer’s financial information and tax returns by the Internal Revenue Service (IRS) or another tax authority to ensure that the taxpayer recorded their income, deductions, and credits correctly and paid the correct amount of taxes.
The IRS may request supporting paperwork such as receipts, invoices, and bank statements during an audit to verify the correctness of the tax return. The audit’s purpose is to ensure that taxpayers follow tax rules and regulations and pay their fair amount of taxes.
Tax audits can be undertaken at random, although they are more typically prompted by specific red flags or irregularities in a taxpayer’s tax return. If it is discovered that a taxpayer has underpaid their taxes, they may be obliged to pay additional taxes, penalties, and interest.
What Are Some Of The Most Common Red Flags That Could Trigger An IRS Tax Audit?
Various warning flags may result in an IRS tax audit. Here are a few of the common ones:
- High income
Taxpayers with high earnings, particularly those earning more than $500,000, are more likely to be audited. The IRS is concerned that high-income households declare their income honestly and pay the correct amount of taxes.
- Large Charitable Donations
Charitable contributions are a frequent itemised tax deduction. However, if a taxpayer’s charitable contributions are much more significant than expected for someone in their income group, this may be cause for concern.
Taxpayers should ensure that they have adequate paperwork to support their charitable deductions, such as receipts or acknowledgement letters from the charitable organisations to whom they have paid.
- Claiming a Home Office Deduction
As the COVID-19 pandemic has caused more people to work from home, home office deductions have grown more frequent. However, this deduction is frequently misapplied and abused.
The IRS investigates home office deductions to confirm their legitimacy. Taxpayers must be able to demonstrate that their home office is utilised only for business activities and is their primary location.
- Filing Late or Not at All
Taxpayers who file their returns late or not at all may face an audit. Because the IRS has the authority to levy fines and interest for late payments, it is critical to file on time to avoid further issues.
- Large Business Expenses
Entrepreneurs that declare significant business expenses may face an audit. The IRS will investigate these costs to see if they are genuine and required for the firm. To justify their deductions, business owners should keep meticulous records of all business expenses.
- Cryptocurrency Transactions
As cryptocurrencies such as Bitcoin gain popularity, the IRS has been more interested in auditing taxpayers who engage in Bitcoin transactions. Taxpayers who fail to declare their cryptocurrency transactions may be audited accurately.
- Foreign Income and Assets
Foreign income and assets must be reported on tax returns by taxpayers who have them. Individuals with international bank accounts are of particular interest to the IRS because they may utilise these accounts to dodge taxes.
Taxpayers who fail to record their overseas income and assets appropriately may be audited.
How to Avoid These Red Flags and Decrease the Chances of Being Audited By the IRS
While there is no foolproof way to avoid being audited by the IRS, there are steps people may take to lessen their chances of raising a red flag.
Here are some pointers to help you eliminate red flags and reduce your chances of an IRS tax audit:
- Be truthful and correct on your tax return
The easiest method to avoid an audit is to be truthful and accurate on your tax return. Ensure that all income, deductions, and credits are accurately reported and backed up with evidence, like receipts, invoices, and bank statements.
Before filing, double-check your return to confirm that all information is correct.
- Maintain good documentation
Good record-keeping is critical for supporting your tax return and reducing the likelihood of an audit. After submitting your tax return, keep all receipts, invoices, and other supporting papers for at least three years. Documentation for charitable contributions, business costs, and other deductions is included.
- Be wary of deductions.
Claiming too many deductions, especially for charity contributions, might raise red flags. Check that you’re only claiming deductions that you’re eligible for and that you have adequate evidence to back them up.
- Declare all income
A common reason for an audit is failure to declare all revenue. Make sure to declare all income, including side jobs, rental properties, and investments.
- File your taxes on time.
Filing your taxes late or not filling them at all can raise a red flag and increase the likelihood of an audit. Make sure to file your taxes on time or request an extension if necessary.
- Use credible tax professionals.
If you hire a tax professional to prepare your tax return, ensure they are reputable and have a strong track record. Avoid tax preparers who make unrealistic promises or engage in unethical practices.
Taxpayers can lessen their risks of getting audited by the IRS by following these guidelines. Remember to preserve proper documentation to support your deductions and credits and to be precise and honest on your tax return.
If you need clarification on any element of your tax return, seek guidance from a tax specialist.
In conclusion, high income, significant charity gifts, claiming a home office deduction, filing late or not at all, significant business expenses, cryptocurrency transactions, and overseas income and assets are all red flags that could result in an IRS tax audit.
Taxpayers can lower their risks of being audited by being accurate and truthful on their tax returns, keeping correct documentation, being careful with deductions, reporting all income, submitting taxes on time, employing trustworthy tax specialists, and considering e-filing.
Taxpayers can reduce the possibility of an audit and ensure that their tax returns are correct and complete by following these guidelines.
Also Read: The Latest Changes to IRS Tax Laws and Regulations