As the tax filing season approaches its end, many worry about being audited by the Internal Revenue Service (IRS). Historically, less than 1% of Americans will be audited (that figure jumps to 12.5% for those making $1 million or more annually)1 and many of these audits are chosen randomly. To help avoid an audit, be aware of things that can capture the IRS’s attention. The following frequently made mistakes could cause your return to be more closely scrutinized and ultimately trigger an audit.
Many returns are selected for audits each year due to basic mistakes such as math miscalculations or forgetting to include signatures. Oversights like these can make IRS reviewers wonder what else you might have missed on your return.
It’s crucial to report all money that you’ve received throughout the year, whether it was income from work, from the sale of an asset, or services performed for which you were paid in cash. If you don’t accurately report all income and the IRS notices, you’ll have to pay back-taxes plus penalties and interest. While it may be tempting to leave some monetary inflows off of your return, the risk is ultimately not worth the reward.
Overestimating the value of donations.
The IRS offers tax deductions for items such as clothes or household goods that are donated to charities. This sounds like a great deal until it comes time to estimate the value of the goods you’ve given away. As a general rule of thumb, the IRS expects the value of donated items to be listed at 1% to 30% of the original purchase price. There are special circumstances that could call for valuing donated items at more than 30% of the original purchase price, but you should be cautious, as this could trigger an audit.2
Home office deductions.
If you work at home, be careful about what you count as a deduction. Only items used to conduct business should be listed — and no, that generally doesn’t include the new bathroom fixtures or sofa you purchased.
Small business ownership.
Similarly, if you own a small business, be cautious. Operations such as bars, restaurants, and hair salons tend to have an even larger bulls-eye on their returns, as these businesses deal mostly in cash. In addition, if you have family members on your payroll, you’re also more likely to get a second look from the IRS.
Income thresholds and tax-sheltered investments.
You’re at a greater risk of being audited if you earn more than $100,000 per year or if you own shares in a limited partnership, control a trust, or take part in other tax-sheltered investments.2 If you find yourself in any of these situations, you should take even greater care to document deductions, donations. and income.
In the event that you do end up being audited, there’s no need to panic. Instead, take a deep breath, and remember these tips:
- Be honest with the auditor.
- Respond to all inquiries as quickly as you can.
- Work with a qualified accountant or attorney, if possible.
Tax season can certainly be tumultuous and audits can cause extra anxiety. However, with a proper game plan in place before and after filing, you can help yourself steer clear of the monetary migraine that tax audits may cause.