Audit. Not a word anyone wants to hear. Of course, considering that the IRS audits about 1% of individual tax returns the general odds of being audited are very low. The IRS says it uses a complex computer model to determine who it will audit, but we can understand more generally how it picks that 1%. After all, no matter what the result, being audited is time-consuming and can do take an emotional and financial toll. Who needs that?
Here's what puts you at risk:
Making an Error in Your Return
Check your math. Then check it again. Having a mistaken calculation on your return is a particularly silly way to invite IRS scrutiny.
Claiming Deductions for a Home Office
The IRS tends to target taxpayers with home offices, so you should be very sure you’re entitled to a deduction for your home office before you take it. In essence, you can claim a home office deduction if a portion of your home is used for business and nothing else, if it's your only workplace. Read on for additional rules about the home office deduction from the IRS.
Claiming High Charitable Contributions Without Receipts
Although you could claim to drop $50 in the collection plate at church every week, doing so might raise a red flag, especially if your income doesn’t seem to support that level of generosity.
Being Paid in Cash
Cash is notoriously hard to track, so if you work in an industry where you receive some of your earnings in cash (waitressing, childcare, etc.), you may be subject to extra scrutiny.
Making A Lot of Money
Obviously, making money isn't something you should stop doing in order to avoid an audit. But the simple truth is that the more you make, the likelier you are to be audited. If you make $100,000 or more, you could be affected by the new IRS effort to audit more high net worth people.
Reporting Income That Doesn’t Precisely Match IRS Records
Make sure to report that extra $100 you earned working in a department store over Christmas, as such errors can draw IRS attention. You’re best off if everything matches precisely; so, if your investment account sends you a 1099 with all your dividend income in a lump sum, report it the same way.
Driving A Lot
The IRS will look closely at returns that claim high deductions for business mileage. Make sure to keep receipts for gas, repairs, and other expenses for business travel. Also, keep of a log of all business-related driving.
Constantly Losing Money From Your Business
If your business never turns a profit, the IRS might scrutinize whether it's a business in the first place, as opposed to being a hobby. Basically, the government doesn't want you to deduct business expenses from something that's not actually a business. We know someone whose accountant warned that his computer repair business could actually be deemed a hobby if it lost money for too many years (presumably because that makes it seem like he does it for pleasure rather than doing it for a serious living). If he continues to deduct his travel expenses, supplies, etc. on his tax return, he's at risk for being audited. If your business loses money over several years, your best bet may be to avoid claiming business expenses on it...especially if it's never turned a profit.
Doing Business With Someone Who Is Audited or Suspected of Fraud
If your return reflects transactions with suspicious characters (or theirs reflect transactions with you), your odds of being investigated go way up. The moral is simple: Avoid financial entanglements with shady people.
Having an Unexplained, Unexpected Deduction
Say that you've never claimed much in the way of business travel before, but this year you took a business-related trip to Fiji. There's a good chance that the IRS software will flag your return for review. Now imagine that, when the auditor examines your return, he or she finds a letter explaining that you were writing an article for a magazine about wedding customs in Fiji. The note would include a copy of the magazine’s contract, and the 1099 from when it paid you for the story. Chances are the auditor will move on to someone else.