Big deductions & large tax credits
Big deductions on a tax return – no matter what they are can also flag the IRS that there’s something wonky with a return. Whether the deduction is a charitable donation, a medical expense, or a gambling loss -- if it’s large, the IRS might take a closer look. So, it’s important to keep good, accurate records for support with any large deductions and credits you feel you’re eligible for.
Claiming an excessive number of credits or some of the larger tax credits can also be a red flag for the IRS – in particular when compared with OTHER data on your tax return.
Business expense deductions & business losses
Meals and travel are common deductions taken on Schedule C by many business owners. If these write-offs are large, that could be a red flag to the IRS.
The IRS is on the lookout for meals or travel deductions that don’t satisfy the strict substantiation rules. Be sure to keep all receipts and documentation for these deductions and any others. Information such as the purchase price, place of purchase, business purpose, and nature of the meeting/travel. Additionally, the 2017 tax reform law (The Tax Cuts and Jobs Act) eliminated the deduction of entertainment expenses. This means that sports tickets, golfing, and other entertainment expenses are no longer deductible.
Another red flag is continuous business losses year over year or reporting a large capital loss – really anything that triggers deductible losses year after year, thereby reducing taxes can be seen as a red flag. The IRS rules allow a Schedule C loss for two out of any five years and a Farming loss for two out of any five years. They are also looking for a business plan and will work with you if these losses are normal in your area, for your business, and based on the current economy. Once again, if you had a business, make sure you keep good records.
100% business use of a vehicle
Depreciating your vehicle can be a red flag if you claim the vehicle is 100% business use. It’s rare for a vehicle to be 100% business use and the IRS is particularly suspicious of individuals who don’t appear to have another vehicle available for personal use. If you do claim a vehicle for 100% business use, be sure to keep detailed mileage records and calendar entries for dates and purposes used, and you better have a second vehicle for personal purposes.
Home office deduction
In 2020, more people than ever worked from home. So, it might be tempting to claim your home office as a deduction on your taxes. However, only a select few individuals qualify. In order to claim your home office on your taxes, you need to be self-employed such as an independent contractor -- you can’t take the deduction if you are a W-2 employee and happen to be working from home.
If you are self-employed, you can get the deduction by:
- Allocating actual costs of the area used for business, or
- Using the simplified option in which you can deduct $5 per square foot of space used for business, with a maximum deduction of $1,500.
Trading or dealing in cryptocurrencies (like Bitcoin or Dogecoin)
The IRS is actively looking at individuals who sell, trade, receive or otherwise deal in cryptocurrencies. The IRS aims to crack down on unreported income stemming from these transactions and are investing a lot of effort and resources to do so. In fact, page one of the 2020 Form 1040 asks specifically if you have received, sold, traded, exchanged or acquired any virtual currency in the last year.
The IRS has teams dedicated to cryptocurrency-related audits and have even gone to federal court to get the names of users with Coinbase accounts. The IRS has a dedicated FAQ page to help individuals who seek to deal in virtual currencies do so in compliance with the law.
Finally, it is your responsibility as a taxpayer to prove your income, deductions, and credits you have claimed on your tax return. It’s important, more than ever, to make sure that your records are up-to-date and match what employers, State agencies, and others will also submit to the IRS. Schedule an appointment today with a nearby Tax Pro to ensure you don’t risk getting an audit.