The IRS scrutinizes your whole financial life during a tax audit, including your income, assets, and expenses. If you cannot show your statement was true to their satisfaction, you could face penalties, fines, or even jail time.
However, most IRS audits are not conducted at random. They are triggered by computer “red lights” that statistically imply sloppy reporting, a high likelihood of undisclosed revenue, or both. Although there is no alternative for employing a trained tax preparer to guarantee that your declaration is complete and accurate, several of the best online tax preparation services, such as H&R Block and Tax Act, now provide notifications if your return has the red flags listed below.
High earnings
According to the most currently available data, the IRS audited 0.62% of all tax returns or one in every 161. However, the larger the stated income, the more likely an audit is.
Taxpayers with an income of more than ten million dollars had a terrifying 14.52% risk of being audited: more than one in every seven declarations. Why? Because that is where the IRS money gets the most bang. They might raise millions of dollars in unpaid taxes if they uncover a billionaire making $10 million a year cheating on his taxes.
Undeclared income
The IRS is aware of your employment, whether you are a W2 employee or a 1099 contract worker.
Unreported revenue is not reported.
The IRS usually requires the payer to file W2 or 1099 documents. Your stockbroker may also deposit 1099s for dividends received on your stocks.
That is correct.
You should wish to hear from the IRS if you fail to declare income, but the IRS obtains paperwork proving you received it.
Even if you receive cash and your employer does not issue 1099, the IRS employs algorithms to compare your spending patterns to your reported income. You can expect to be audited if they do not match.
High deductions compared to income
If you make $95,000 a year at your employment but claim $90,000 in tax deductions, you can bet the IRS will raise an eyebrow.
Inflated business expenses
Deducting company expenses on Schedule C is a dream come true for self-employed taxpayers. They can still take the standard deduction, but they can also deduct various costs, including travel, a home office, and office supplies. Even better, the business expenses deducted here minimize both their income tax and self-employment tax liability.
Foreign Financial Accounts
If you have more than $10,000 in foreign financial accounts at any point during the year, you must file a FinCEN 114 (FBAR) report. Failure to do so can result in severe consequences.
Cash-intensive companies
For IRS audits, restaurants, bars, hair salons, nail salons, car washes, and other cash-only or cash-intensive enterprises should be prepared. Why is that? Because the IRS is aware that cash-intensive enterprises are more likely to underreport their earnings, the IRS has taken steps to ensure that this does not happen.
Claim the same dependent twice
A child can only be declared dependent by a parent.
If you are married but filing separately or if you are divorced, one parent will be unable to file. Use the IRS Publication 501 tie-breaker rule if necessary.
Claim rental losses
The tax advantages are one of the many advantages of real estate investing. If you are claiming losses from a rental property, be prepared to provide evidence.
Rental losses are not deductible from taxable income.
Report losses for a hobby
Tax deductions for hobby expenses are not available. Period.
The activity must have a realistic expectation of profit and be managed like a business to qualify as a legitimate business with deductible costs.
Not declaring gambling winnings
Many recreational gamblers are unaware that casinos file Form W-2G with the IRS. They know more than you believe, and you can expect an audit if the casino reports a large win from you and you fail to report it.
Final Words
There has been a lot of chatter in recent years about robots and automation replacing all employment. Given the rule-based and logic-based tax preparation, accountants are firmly on the endangered professions list.
Tax laws give so much flexibility for interpretation that it is frequently necessary to decide. An accountant is one of the financial experts you should contact when your tax return grows larger and more involved.
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