What the IRS Says About Audit Triggers

The IRS has annual national Tax Forums where they discuss, among other things, what can make your tax return an audit targetⁱ. The reference is to one forum’s presentation slides in a .pdf file. They outline what the IRS says are audit triggers that can make you a target for scrutiny. The audit information was compiled from 2016 tax returns, and the discussion included:

• How the IRS selects tax returns for audit.
• In an ongoing audit, the areas of the return that are scrutinized more.
• Areas of a return that are commonly audited large itemized or business deductions.

Keep in mind that this is a constantly-changing target area, so it is best to stay up to date through consultations with tax advisors who stay in-the-know about audits. It is true that fewer than 1% of tax returns are audited, but if you have ever played roulette, your number just may come up.

Target: Unreported Income

Not reporting some income is more common than you may think, and the IRS has some great tools to discover discrepancies. First, they are matching information on forms W-2, 1098, and 1099. Even if you report all income on Form 1099 that you receive, are you certain that you received all you should have? While a business may miss sending you your copy or have an incorrect address, they send everything to the IRS to substantiate their deductions. And there are five Form 1099 versions:

• 1099-C – Cancellation of Debt
• 1099-K – Merchant Card and Third Party Network Payments
• 1099-R – Distributions from Pensions, Annuities, Retirement Plans, IRAs, or Insurance Contracts
• 1099-CAP – Changes in Corporate Control and Capital Structure
• 1099-MISC – Miscellaneous Income

Keep good records, as not receiving one of those is not a valid excuse for non-payment of taxes due.

Target: Large Itemized or Business Deductions

Computers have been a boon for personal and business use, but their power can bite you if your business return deductions are out of the norm. The IRS computer databases can pinpoint deductions out of the norm for the type and size of your business. This invites scrutiny, and even if yours are legitimate, the IRS is into your business and can look at everything else. Here are the deductions that the IRS says are frequent triggers for audit:

• Charitable contributions:
  • The IRS tracks your generosity based on your Adjusted Gross Income and will spot years with higher than normal contributions.
  • Poor record-keeping creates problems.
  • Check out these publications:
    • IRS Publication 4303 – Donor’s Guide to Vehicle Donation
    • IRS Publication 536 - Charitable Contributions
    • IRS Publication 561 – Determining the Value of Donated Property
• Home office deduction:
  • Out of the norm regular or simplified method deductions for a home office
  • Qualification as to regular and exclusive use
  • Is it the principal place of your business
  • Check out IRS Publication 8829 – Business Use of Your Home
• Car and truck expenses:
  • Only use standard mileage deduction or actual expenses, not both
  • Lack of adequate records to substantiate business use
• Meals and entertainment/travel:
  • Excessive deductions without a valid business purpose
  • Poor record-keeping for validation

Target: Schedule C - Sole Proprietorship Profit or Loss from Business

The Schedule C is where you have multiple opportunities to invite IRS scrutiny. Without detailing the many pitfalls and triggers, here are the things you should consider critical:

• Keep proper records – This is crucial. In every facet of your business for both income and expenses, keep detailed records, receipts, and documentation.
• Unreported income, even if you do not receive a Form 1099, is a problem.
• While your audit risk does increase as your receipts grow, trying to keep receipts lower with creative accounting is worse.

With COVID came more work from home and even more independent contractor situations. Get your ducks in a row or risk an IRS audit.

Target: Other Miscellaneous Flags for Audit

Business or Hobby? – If you are going to call it a business, you should operate it like one and for a profit. Consistent losses will get the IRS into your business, and it will be reclassified as a hobby.

Rental Losses from Real Estate – Unless you are classified as a Real Estate Professional, reporting losses on rental properties can get you into an audit situation.

Large Cash Transactions – When it comes to cash transactions more than $10,000, you are asking for IRS action, as these are reportable by financial institutions.

If you want to operate a business free of IRS questions or audits, it is best to get your record-keeping and business practices in line with IRS guidelines.

i Tax Audits-Triggers and Tips – IRS.gov