Your chances of being audited go up as your income gets higher. Individuals with an income under $200,000 have less than a 1% chance of being audited. An income of $200,000 or more will triple your chance of being audited. And those with incomes over $1 million have close to an 11% chance. So, the more income shown on your return, the more likely it is that you'll be hearing from the IRS. That being said, there are several other factors than can cause the IRS to take a second look at your return.
First off, most tax returns are processed by IRS computers. The computers watch for anything out of the ordinary, anything that strays too far from the norms. An item that falls outside the norm may be flagged, increasing the likelihood that a return will be audited. A flagged return will be manually reviewed by an IRS employee to determine if there's an actual need for an audit. Below are a few of the most common audit triggers.
Not Reporting All Income
The IRS gets copies of all 1099s and W-2s, so make sure you report this income. IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. If you receive a 1099 showing income that isn't yours or listing incorrect income, get the issuer to file a correct form with the IRS.
Large Charitable Deductions
The IRS knows the average size of charitable contributions based on income levels. If you take a deduction for an amount that is quite a bit larger than the averages, you should expect a letter. In addition, if you have charitable contributions that consist of high valued property (over $500), be prepared to provide a legitimate appraisal and other documentation. Appraisals are often challenged by the IRS.
Claiming Rental Losses
The IRS is actively scrutinizing rental real estate losses, especially those written off by taxpayers claiming to be real estate pros and whose W-2 forms or other businesses show lots of income. The IRS checks to see if you have worked the necessary hours, especially if your day jobs is not in the real estate business.
Deducting Business Meals, Travel and Entertainment
Large meal, travel, and entertainment write-offs here will set off the alarms. The IRS knows from experience that self-employed individuals who claim deductions on Schedule C will often claim excessive deductions and they look at both high grossing sole proprietorships and smaller ones.
Remember, with meal or entertainment deductions, you must keep detailed records that document each expense the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting. Also, you must keep receipts for expenses over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction will be disallowed.
With all of this being said, it doesn't make sense to not take a deduction you're entitled to. Just make sure you're entitled to the deduction and have the required records to back it up. Next week, we will go over some more triggers that could get your return flagged for an audit.