5 Warning Signs That Could Trigger a Tax Audit
An IRS audit—an extra close review of your tax return to make sure it's accurate—is something everyone wants to avoid. Even if no errors are found, it can be time-consuming, expensive, and stressful.
For most people, the odds of having your tax return audited are quite low—based on the latest data from the IRS, only 0.5 percent of all returns were audited during the fiscal year of 2017. Still, that half percent added up to some 1.1 million taxpayers who had to go through the uncomfortable process of a federal tax audit. Here’s how long you should be keeping your tax returns and supporting documents, in case you’re ever selected for an audit of your own.
How items are tagged for potential abuse
The IRS utilizes high-powered software that “verifies the information provided in tax returns is accurate and complies with applicable tax code regulations,” says Riley Adams, CPA, senior financial analyst for a Fortune 500 company in New Orleans and founder of Young and the Invested. “When the IRS processes incoming returns, it marks certain sensitive areas for potential abuse and more rigorous checking.” Read on to find out what those areas are.
1. You claimed the earned income tax credit
The Earned Income Tax Credit (EITC) is intended for those with low to moderate income. “The IRS wants to be sure any tax refund goes to a qualified taxpayer and not someone scamming the system,” Adams says. It will take particular note of any dependents you may have claimed and verify that another taxpayer has not also claimed them.
2. You brought in a lot of money, but have a low adjusted gross income
If you make a lot of money, the IRS wants to make sure you are paying your fair share. “When the IRS sees a taxpayer with a very high gross income but almost no adjusted gross income, they will want to know why such a disparity exists.” It may well be that you claimed legitimate deductions or business losses, just be prepared to back those up. That’s why you’ll want to hang on to these 10 financial-related documents forever.
3. You didn’t report all of the income you earned
Another mistake you’ll want to avoid when you file your taxes is failing to report all the money you earned from various sources. “When it comes to reporting your day job income on your tax return, you know the drill: get your W-2 and input the data into your tax software,” says Logan Allec, CPA, owner of the personal finance site, Money Done Right. But what if you have a side hustle or freelance gig? You may have received a 1099 for the income you earned from the person or business, but you might not have. However, “If you didn’t receive a 1099, this in no way means that don’t need to report this income on your tax return. You do!”
4. You claimed a large number of charitable contributions
Since the IRS doesn’t receive a tax form showing how much you donated to charity this year; it’s up to you to accurately self-report how much you gave in donations—in cash or goods, such as gently used clothing or furniture. While the average taxpayer will likely not flat-out lie about the amount of cash he or she gave to charity, they might be tempted to exaggerate the fair market value of goods donated. The IRS “has a pretty good idea of how much people at various income levels donate during the year,” Allec says. “If you’re an outlier for your income level—watch out!” You’ll also want to make sure you donated items to a qualified charitable organization; that $5 you gave a panhandler on the street doesn’t count.
5. You claimed you are a real estate professional
Being a real estate professional, someone who rents properties, can provide terrific tax benefits, explains Bill Smith, managing director for CBIZ MHM’s National Tax Office. “If you satisfy the requirements, real estate losses are not passive, which means you can deduct them against your other income.”
To qualify as a real estate professional, “more than half of your personal services must be performed in ‘real property trades or businesses’ in which you materially participate and you must perform more than 750 hours of services during the taxable year in real property trades or businesses in which you materially participate,” Smith says. Translation: You have to spend around 15 hours a week attending to your rental property business.
“If you are already working 40 hours a week at your W-2 job, the IRS might want to investigate if you really have the energy to work that extra 15 hours, and why you would need to,” Smith says.