On 12/19/16 Fox Business News published “9 Tax Audit Red Flags for the IRS” by Sean Williams.
As a background, the Tax Foundation found that the US Tax Code is now 10.1m words. The instructions to complete a basic Form 1040 are more than 100 pages long. Although historically the IRS only audits about 1% of the tax returns, greater risk of audit includes:
1) Filing a paper tax return (not e-tax return). The audit risk is due a greater chance of making a math error than online software. According to turbo tax, paper returns have a 21% error rate compared to 0.5% of e-filed returns, i.e. a 41 times greater chance of making an error and being audited by the IRS;
2) Claiming a home office deduction. Taking the deduction does not trigger the audit. The IRS looks at large home office deductions. The deduction is limited to space dedicated to your work and not your personal life;
3) High Earners. In 2014, the IRS increased the audit risk by 3x for those with adjusted gross income between $100k-$499,999;
Audit Risk (2014): High Earners
1) $1m (and over) 6.21%
2) $5m (and over) 10.53%
3) $10m (and over) 16.22%
4) Schedule C. Ongoing losses may trigger an IRS audit. The IRS considers a business to be engaged in a for-profit activity if it reports a profit in 3 out of the last 5 years. A business that regularly posts losses year after year may be classified as a hobby, which would wipe the net loss on the original tax return and may result in tax, penalty & interest;
5) Excessive Business Expenses are claimed, i.e. personal expenses are claimed as business deductions;
6) Excessive Charitable Contributions: The charitable contribution is excessive in light of the income e.g. $50,000 income but claim a $15,000 deduction for charitable contributions. In addition, charitable contributions require documentation to confirm the contribution;
7) Failure to include Form 1099 income received e.g. freelance income, dividend/interest income. This income is automatically reported to the IRS so if you fail to include the income and report it on tax returns you increase your audit risk.