Chief Tax Information Officer
Published on: June 19, 2019
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The purpose of an IRS audit is to verify the financial information you’ve included in your tax return is correct. An audit helps the IRS determine if you have adhered to tax law and reported the correct amount of income, or claimed legitimate deductions or credits. An audit can take place in person or via mail.
The process of selecting tax returns for audits by the IRS is partly done by computers, since the comparing information received from third parties to information on the tax return has been automated. If the computer generates an audit letter, it doesn’t necessarily mean you have done anything wrong, just that an anomaly has been detected on your return, and raised a red flag. This could be a simple mistake, such as a typo, or the IRS may need supporting documentation for your claim.
Being careful when submitting your tax returns can help you avoid mismatch audits. Other factors like high income or extremely low income may be unavoidable, but the appropriate supporting documents should be able to resolve matters, getting you out of an audit without extra penalties or interest.
While you shouldn’t necessarily be afraid of these potential flags, it would help to keep them in mind while filing your taxes.
A large tax refund in itself is not a red flag. However, if the refund is a result of fraudulent claims, such as inaccurately reporting income or claiming deductions you are not actually eligible for, then it can trigger an IRS audit.
Your return is more likely to come under scrutiny if your income has decreased significantly or your charitable deductions have significantly increased, leading to an unusually large tax refund.
There is no reason for the IRS to initiate an audit based on the charitable deductions you have claimed, unless it is disproportionate to your income. According to the IRS, you can deduct charitable contributions amounting up to 60% of your Adjusted Gross Income (AGI), and if your deductions are above this, they can be carried forward to the next year. Do not make false claims, and ensure you have all necessary receipts and any other documentation you need to prove your charitable donations.
The IRS allows taxpayers to round to the nearest dollar when completing their return. Taxpayers should round down at 49 cents or below, and up at 50 cents or above. For example, a taxpayer with an income of $42,159.60 would round to $42,160 – but an income of $51,268.49 would be rounded to $51,268.
There is a fine line between a hobby and a business when it comes to tax rules. Claiming your hobby as a business when you have not demonstrated a net profit in at least three of the preceding five years can lead to an IRS audit. The IRS has a number of methods to distinguish a business from a hobby – a taxpayer must have a business plan and show an attempt to make a profit.
No. Checking to see if you have received your refund does not trigger an audit. But there are many other factors that can lead the IRS to take a closer look at your return – such as math errors, failure to report income, or too many deductions claimed. Since the IRS can pursue an audit for up to three years after the return was filed, it is possible to be audited even after you have received a refund.
Claiming a home office deduction is a red flag to the IRS primarily because a lot of people tend to misuse the deduction. According to the IRS, a home office deduction is to be claimed by people who use a part of their home exclusively for business or trade purposes. If you have a room or separate area of your home that you use exclusively for business, you may be able to deduct the business portion of your expenses on your tax return. You must be self-employed, and the space should be a place that is not used for any other purpose or personal use, other than your work. You could be in trouble if you claim a home office deduction while working a few hours every week at a desk with a computer set up in your living room or spare bedroom.
This is a major red flag for the IRS, especially if the nation in question is one that has tax laws which are much more lenient than the US. Of late, the IRS has been strictly monitoring such tax returns. You must report all foreign accounts that you hold with a total cumulative balance exceeding $10,000. If your foreign assets are valued in excess of $50,000, these must also be reported. In most cases, the IRS can seek information about your account from the foreign bank.
All this does not mean that you have to live in fear of an audit all the time. Maintaining accurate records and keeping the proof ready for all the deductions claimed and income reported will ensure that you have nothing to worry about, even if an audit is conducted.
About the Author
Mark Steber is Senior Vice President and Chief Tax Information Officer for Jackson Hewitt. With over 30 years of experience, he oversees tax service delivery, quality assurance and tax law adherence. Mark is Jackson Hewitt’s national spokesperson and liaison to the Internal Revenue Service and other government authorities. He is a Certified Public Accountant (CPA), holds registrations in Alabama and Georgia, and is an expert on consumer income taxes including electronic tax and tax data protection.