Nobody wants to face an audit from the Internal Revenue Service. Luckily, the probability of being audited is quite small for the average taxpayer.
It’s estimated that only 0.6 percent of taxpayers are likely to be audited. If you report zero gross adjusted income, the probability of being audited increases to just under 2.6 percent.
According to TurboTax, the red flags that increase the probability of being audited are: having a home business that loses money each year; taking a home office deduction, especially when you claim a high percentage of your living space is used for business; and claiming a high proportion of itemized deductions to income.
An example of the latter might be someone who takes deductions of $40,000 on an income of $60,000.
If you do prepare your tax return using TurboTax software, you can use their audit support options if you are audited.
As you would expect, if there are errors on your return, there is a higher probability of being audited. E-filing helps reduce error rates; the error rate for electronically filed returns is 0.5 percent. The error rate associated with paper returns is 21 percent, according to TurboTax.
There are certain errors that the IRS is almost certain to discover. For example, make sure you report dependents and exemptions accurately. The IRS automated system will easily detect any discrepancies based on prior returns.
If you are self-employed and file Schedule C, you are four times more likely to receive questions about your return. Make sure that you maintain good records for all of your deductions. If you believe a specific deduction may be questioned by the IRS, you may want to include in your return a copy of the receipt associated with the expense.
I file Schedule C every year, and I regularly include such documentation. I have not been audited, despite filing Schedule C every year.
Another way to raise suspicion is contributing more than 30 percent of your income to charity. (If you are over 70 1/2 and subject to required minimum distributions, and use the standard deduction, have your contributions made directly from the custodian of your IRA to the qualified charity. This will reduce your adjustable taxable income and your income tax.)
Other red flags are bad debt expenses, casualty losses, high medical expenses, business travel, and high meal and entertainment expenses. Make sure you retain proper documentation of these expenses in case of an audit.
When appropriate, document the participants and where and when the expense occurred.
Do not claim unreimbursed employee business expenses. This deduction is suspended through 2025.
It is not unusual for taxpayers to receive notices from the IRS regarding their returns. These notices can specify that you owe additional taxes, that you made errors on your return or that you are receiving a higher refund. Or they may request additional information.
Pay attention to the tax year associated with the notice. It may be for a prior year.
You generally will have 30 days to respond to an IRS notice. If you agree that you owe additional taxes, reply within the 30 days with a check or money order using the reference number indicated on the notice, including the voucher included with the notice.
Not responding within 30 days will result in additional fines if you owe money. Don’t assume you will be audited as a result of an IRS notice. However, you should always respond within 30 days. Delaying a response past 30 days will never work to your advantage.
If you don’t agree with the notice, respond as soon as possible with a written explanation. Explain clearly the reason for disagreement and include copies of all relevant documents.
Keep the originals for your files. You should maintain a separate file including the IRS notice and your responses.
Elliot Raphaelson welcomes your questions and comments at firstname.lastname@example.org.