IRS Audit Triggers

Federal tax form 1040 with keyboard and calculatorSmall and Mid-Sized Business CPA Services -3 Ways to Avoid the IRS Tax Audit

Our current annual review of the top IRS audit triggers is here. We don’t publish this to scare people away from legitimate claims, but do feel you need to be aware of the things that will draw attention to your return.

If you’ll be claiming credits and deductions that can lead to close scrutiny, you’ll want to bullet-proof your claims with excellent documentation. Scottsdale/Phoenix companies have hired us for over 35 years for our small business CPA services.  We work hand-in-hand with our clients to give them the most in depth review of qualifications and restrictions. We teach them, “Claim what you have the right to claim, but remain compliant.”

What Might Trigger an IRS Audit?

As we’ve said in the past, there are certain claims and deductions that have a history of abuse. Naturally, the IRS has therefore built systems to identify possible abuses. Additionally, income level can play a role in how closely your return is examined.

The same kinds of deductions can result in greater dollar amounts as income levels increase. Consider it a cost efficiency measure on the part of the IRS to use its resources where the benefit is likely to be greatest.

With that said, let’s look at some things that could result in the IRS pulling your return for a manual review.

Unusually High Deductions

Whether a deduction is uncharacteristically high based on your history, or if a deduction stands out as unusually high for the industry you’re in, the IRS takes an interest in unusually high deductions. They may ask you for an explanation if a deduction you claim is high (proportionally) compared to the same deductions claimed by others in your industry.

Home Office Deductions

Usually at or near the top of any list of IRS audit triggers, the Home Office deduction was been simplified for 2014 tax years and forward.  We’ll be watching to see how this one shakes out. You now have the option to take $5 per square foot of office space up to 300 square feet.

That sets an effective limit of $1,500 on the claim, but those who keep excellent records and can show greater expenses might choose to itemize their interest, rent and other expenses on Schedule C.

Business Use of a Vehicle

Reporting business use of a vehicle binds you to extensive record keeping. Every mile of every trip must be reported in detailed logs. Expenses for insurance and up-keep aren’t allowed if you use the IRS standard mileage rate. You can’t have it both ways, and the IRS will take a close look at vehicle use, because it has been so frequently abused in the past.

Claiming Losses On Rentals

There are strict rules and increasingly strict enforcement of the rules for reporting rental losses. To claim rental losses, half or more of your working hours and not less than 750 hours per year must be spent directly involved in developing, brokering or acting as landlord over your rental properties.

If you work a regular job, claiming a loss on rental properties can certainly get your return pulled for a closer look. The IRS has been aggressive and successful with claims of this kind in recent years. Just be sure you qualify before claiming such losses.

Business Travel and Entertainment

One of the most abused deductions, frequently scrutinized, travel expenses must be well documented and must be sensible and proportional to the business. Claiming a large, out of the ordinary deduction for travel and entertainment is like asking the IRS to take a closer look at your entire return.

Investors Beware | Reporting Losses in Day Trading

To benefit from the tax advantages of qualifying as a trader, trading must be continuous and consistent with practices aimed leveraging short-term price swings. Many investors error when claiming day-trading losses on Schedule C when they are In fact investors.

Know the difference between investing and trading and avoid risking the close scrutiny of an audit.

Charitable Contributions

Charitable Contributions make the list every year, so document everything. Get appraisals for donated property. File Form 8283 for non-cash donations of $500 or more. Also, be sure that your charity is eligible for tax-exempt donations.

Loss From a Hobby

While you must report income from a hobby, you can’t claim losses from a hobby. For the purpose of claiming a loss, you must demonstrate that your activity generates a profit in 3 out of 5 years (2 of 7 for horse breeding).

You can claim and deduct expenses up to the level of earnings, but can’t write it off if your hobby leaves you upside down.

Failure to Report Income | Inaccurate Income

The IRS gets all of the 1099s and W2s that you do. You simply must report that income or risk close scrutiny. And, If you get a W2 or 1099 that isn’t accurate, have it corrected.

Simply correcting the numbers on your return without making sure the issuer has sent the correct the data to the IRS will result in a return that doesn’t match the numbers the IRS expects.

Income Level

As we said above, your income level can play a role in how closely the IRS looks at your return.

Less than 1 in 100 people filing returns on income less than $200,000 faced an audit last year, compared to just over 3% of persons reporting income over $200,00.  Among those reporting at least $1 million in earnings, 1 in 9 were audited.

The more you earn, the more likely you need the depth of knowledge as is found at our Scottsdale CPA firm.  If you have a complex return, high income or both, you should explain your exact situation and get the appropriate accounting and consulting assistance.

In Summary

Don’t be afraid to claim what is rightfully yours. Do be aware of the requisite restrictions, limitations and qualifications needed to be audit-proof – especially when claiming deductions that are known to result in close IRS scrutiny.

The best advice is to review your unique situation with us. As your return grows more complex and/or your income level rises, this becomes even more important.