11 Red Flags that Draw IRS Attention

No one wants to get audited – and most people don’t. But if you really want to avoid unwanted attention from IRS auditors, you need to know about these 11 red flags in your tax return that may spark their interest.

  1. Making more than $200,000 a year: IRS statistics show that the audit rate jumps to 2.6% for people earning at least $200,000 a year… and soars to about 10% if you make $1 million or more. But less than 1% of people earning less than $200,000 get audited.
  2. Not reporting all of your taxable income: Every W-2 and 1099 you receive is also sent to the IRS, and their computers automatically look for matches between their records and your tax return. If something doesn’t match – like you typed a number incorrectly or left something out – the computers flag it, and the IRS will come to call. If you get a 1099 or W-2 that isn’t really yours, or that reports the wrong amount of income, contact whoever issued it and have them file a corrected form.
  3. Owning a small business: The IRS scours the tax returns of small business owners, especially those with mostly cash businesses (like bars and restaurants) or those with big losses reported on their Schedule C. The agency has also been looking into a lot of LLCs (limited liability companies) and S corporations, fishing for extra revenues.
  4. Reporting losses in rental properties: Special rules usually keep people from deducting losses on rental real estate unless they “actively participate” in the rental activity (like a hands-on landlord) or they’re real estate professionals who meet special active participation requirements. The IRS has begun taking a magnifying glass to rental losses claimed by both groups, looking especially hard at people with W-2 jobs unrelated to real estate.
  5. Taking more deductions than expected: The IRS pays a lot of attention to averages, especially when it comes to income levels and itemized deductions. If your Schedule A deductions are higher than the average for your income level, your return could be singled out for audit. That shouldn’t stop you from claiming every legitimate deduction you have. As long as you have proper documentation for everything, they won’t get an extra dime out of you.
  6. Supersized charitable donations: Among the Schedule A deductions, the IRS pays the most attention to charitable donations that seem over the top compared to your income level (remember, they track all those averages). Remember, there’s an extra form to fill out for non-cash donations over $500. And if you donate valuable property (like a car), make sure to get it appraised before you take the deduction.
  7. Travel and entertainment expenses: Deductions – especially really big ones – for business meals, travel, and entertainment raise a bright red flag, whether they show up on a Schedule C (for a business owner) or a Schedule A (for an employee). There are pretty strict rules for taking these deductions, including detailed records of each expenditure and an original receipt requirement for any expense greater than $75 or for lodging when you travel. As long as you have proper documentation, don’t be afraid to take the deduction – but be aware that you might get called in to substantiate it.
  8. 100% business use of a car or SUV: The IRS knows that virtually no one uses a business vehicle for strictly business 100% of the time… especially if you don’t own another vehicle. So when you fill out Form 4562, be careful about the percent of business use you claim. This is another place where documentation can make all the difference. Without a detailed mileage log/calendar to back you up, the agent may disallow your deduction.
  9. Taking the home office deduction: The IRS loves to knock out the home office deduction, and they prevail more often than not. They especially focus in on this when you’re showing a loss on Schedule C or your tax return also includes salary income. But if you really use your home office regularly and exclusively for business (it can’t double as a guest room), don’t be afraid to take the deduction.
  10. A deduction for alimony: Alimony is a tricky thing tax-wise. Technically, it’s deductible to the person paying it, and taxable to the person receiving it – but the details really count. To count as alimony, that has to be spelled out in a legal agreement, which has to include a provision that says the payments stop when the recipient dies. It has to be paid by cash or check directly to the ex-spouse – not to the landlord or electric company. And it doesn’t include child support. If your alimony payments meet all the detailed requirements, your ex has to report the same exact amount as income or both of your returns will be flagged for the mismatch, and you’ll almost certainly get audited.
  11. Getting an early payout from a retirement account: If you’re younger than 59½ and you take money out of your IRA or 401(k), the IRS is paying attention. You’re only allowed to touch that money before retirement age under specific circumstances – and even then there’s a 10% penalty charged (unless you meet certain hardship exceptions) in addition to the regular income tax you have to pay on money you took out. A lot of taxpayers get this wrong – and the IRS is ready to pounce.
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