Global Tax Insights
What Prompts an IRS Tax Audit?October 02, 2014
Be sure to review your tax return and make yourself aware of certain entries that the IRS is likely to scrutinize.
Looking to avoid an IRS tax audit? There are several items on your tax return that the IRS is likely to dissect. Be sure to carefully review all entries on your return to avoid a dreaded letter from the IRS.
What entries does the IRS examine?
For individuals specifically, recent years have shown that returns that indicate reporting income of $1 million or more stand the greatest chance of receiving a tax audit. Apart from income, the IRS is likely to send a tax audit to both individuals and businesses to double check entries like:
- Unreported income- Failure to report taxable income such as interest, dividends, non-employee compensation, gambling winnings will surely prompt an IRS letter or even an audit. Remember the IRS received copies of all Forms 1099s, W-2s, W-2Gs, etc.
- Charitable contributions- Since the IRS publishes data on the standard size of charitable donations for different income levels, you could attract their attention if you take a deduction for an amount that is materially larger than the average for your income level. Charitable contributions of property often require an appraisal and specific return attachments that could be inspected by the IRS. This is not to suggest that you refrain from being charitable; the key is to maintain proper documentation/appraisals to substantiate the deductions in the event of an audit.
- Foreign bank accounts- There are severe penalties for failure to report foreign bank accounts including signature authorities on accounts that you may not even own directly. The IRS now receives information from many foreign bank accounts. Checking off that you have one on Schedule B could heighten the chances for an audit, and not checking it off when you should, could warrant an audit as well.
- Cash Transactions- It is mandatory for banks and merchants to report to the IRS cash transactions that exceed $10,000. If you make large cash purchases or deposits, you could be scrutinized.
- Home business- In order to deduct the expenses and depreciation attached to a home office space, you must show that the space is used entirely for business purposes. For the most part, you stand a greater chance for an audit if you claim a significantly high percentage of your home for business purposes.
Losses- There are a variety of losses that the IRS will scrutinize, including but not limited to:
- Gambling losses- Though you are permitted to deduct losses equal to the amount of your winnings, the IRS is aware that many taxpayers do not keep the required records.
- Bad debt losses- It is difficult for taxpayers to win in this area, because it is tough to show the existence of a bona fide debt or the occurrence of a loss in an earlier or later year.
- Casualty losses- For this entry, appraisals and other outside information may be required, which could get complicated.
- Crowdfunding- Funds raised through small donations or investments via social media/internet must be reported to the IRS as taxable income. Don't make the mistake of reporting funding efforts as non-taxable hobbies!
- Maintenance and repairs- Sometimes there is a difference between what property owners consider a repair and what the IRS considers a repair. You may be required to depreciate expenses that you deducted on your return.
- Business Meals, Travel and Entertainment- Big deductions for meals, travel and entertainment are always a red flag for an audit. Make sure to keep detailed records documenting the business purpose and the client name for each item of expense.
Don't panic when you see a letter from the IRS. Sometimes, the IRS is simply asking for more information when they request an audit. For issues involving one or two items on a return, correspondence audits are the most popular type of audit. The letter will indicate the documents taxpayers have to provide (within 30 days) to eliminate any suspicion regarding their return.
In order to rightfully claim deductions, it is important to make sure you are fully entitled. Seek advice from a tax advisor if you are unsure. Contact any member of our Tax Services Group for further guidance on tax audits and what the IRS is looking for.