Eric Day, Esq.
10 Reasons You Might Get Audited
When I have conversations with individuals in a professional setting, they will often ask what type of attorney I am, to which I respond, “A Tax Attorney.” Without fail, the two most likely options for their next reply are; “Why taxes?” or “How can I avoid getting audited?” To the first question, taxes aren’t all that bad. In fact, there is a lot of opportunity in the tax code for any business owner to legally save money on their taxes. You just need to be pointed in the right direction. To the second question, I have decided to dedicate this blog post to some of the reasons you might find yourself in an audit soon. Remember, just because there is a risk of audit doesn’t mean you shouldn’t take the deduction. Just make sure there is ample evidence to support the position you take.
1. Making More Money
I am by no means saying don’t make more money. Just realize that more money you do make the IRS has potential to get more bang for their buck. Statistically, once you get into the $500,000 range of personal income, you jump from about 0.7% chance of being audited to 1.56%. That is more than double the likelihood of receiving an audit letter from the IRS, although the percentage is still small. Once you reach $1,000,000 of personal income you jump to 3.52% with 7.95% chance when you make above $5,000,000 and 14.52% when your income is $10,000,000+.
2. Rounding Numbers
I can’t remember a time in my entire life, when for a whole entire year, all my expenses rounded out to the nearest tenth or hundredth on the receipt. This is exactly the type of thing that will alert the IRS of deceit. When every expense on your return is rounded to the nearest $100 it looks like “made up” figures. Instead of just rounding each figure up to the nearest $100, make sure to use exact figures and stay off the radar.
3. Writing Off Hobbies
Just because you’re signed up to sell “essential oils” to get a discount on the oils you purchase for yourself, doesn’t make this a business. Even the occasional sale here and there will not equate to business activity. Ten years with a $10,000 loss is not what I call a good business model. There must be a reasonable expectation on the part of the taxpayer to earn a profit for the expenses (losses) to hold weight on your return. If you make a profit 3 out of the past 5 years, the IRS will concede that this is in fact a business. Don’t worry, for those of you that make the occasional sale with your “hobby,” you are still allowed to write off related expenses up to the amount of income you receive.
4. High Charitable Donations
Some of you might be wondering why this would be audited so much. Doesn’t the IRS want us to contribute to the needy? Well yes, that’s actually why you get a deduction for it. However, the normal taxpayer contributes about 3% of their total income to charitable organizations. Therefore, you could imagine if you are substantially above that amount, it might make some heads turn. Don’t let this deter you from giving. One of the greatest joys in life is being able to give back to those less fortunate. Just make sure you keep receipts from the charitable organization you contributed property or cash to and that the receipts indicate you did not receive any goods or services as consideration for what you provided.
5. Claiming to Many Expenses on a Schedule C
Typically, when you first go into business, you will tend to start out as a sole proprietor. As a sole proprietor your income and deductions are reported directly on your individual tax return on a Schedule C. This could cut down on the cost of returns, but it also allows the IRS to see the information in direct relationship to you, the taxpayer. Because the sole proprietor is not as likely to use a CPA or tax professional to handle their affairs, it is more likely that you will understate your income or overstate your expenses. When including your expenses on your return, make sure the expenses are ordinary and necessary for the business to operate. Otherwise, they are not deductible. Keep all your receipts related to those expenses so that you can substantiate them when the IRS asks. Finally, with expenses like auto mileage or travel expenses, keep all receipts as well as a log with a description of the business purpose for the trips.
6. Home Office Deduction
The home office deduction is one tax deduction that will almost surely land you in the IRS office. This is simply because there are too many people spreading the word about the home office that have no idea what it is or how it’s deductible. With a home office, you likely will have a room in your house that is used strictly for business purposes. When I say strictly, I mean NO PERSONAL USE. If you truly have a home office, you can deduct certain living expenses related to that room (ie. Depreciation, utilities, insurance, repairs, etc.). This is a great opportunity for tax deductions when used correctly.
7. Forgetting About Income (Not Reporting It)
You know when you lie to your parents and they know you so well that they can tell you are lying? Well the IRS has their own way of knowing whether you are lying or not honestly reporting your income. Sure, some of us make mistakes or keep bad records, but this will surely land you in an audit. Employers or Individuals that hire you for services that you provide will pay you a fee for your services. This will require them to file a W-2 or 1099 with the IRS. The most common correspondence audit I receive is a taxpayer that failed to report all the 1099 income they received throughout the year.
8. Claiming Rental Losses
Real estate is a great tool for taxpayers to accumulate losses to offset their other income. However, there are limits to the amounts of losses you can take depending on the taxpayer’s real estate status. Renting is ordinarily seen as a passive activity. Passive activity losses are not deductible on your return unless you have passive activity gains to offset with those losses. Real estate professionals and active real estate investors can write off these losses completely or at least a portion of them. However, if you include these losses on your return, there is a good chance the IRS is going to flag your return for audit potential. This is one of those areas where knowing the law completely is most beneficial when trying to get these losses included.
9. Filing Your Return without Reviewing It
I know, I know, why do we have tax professionals if we must review the return anyway? The easiest way to bring on the scrutiny of the IRS is to file your return with mistakes on it. The downfall to this is a lot of the mistakes that are made are unintentional but can have devastating consequences at times. Review your returns and if you see something you are not familiar with, ask your “tax guy.” I mean, what do you pay them for anyway?
10. Running a Cash Business
Remember when I mentioned that there are income items that get reported to the IRS to prevent individuals from not honestly reporting their income. Well cash businesses (hair salons, bars, car washes, etc.) don’t necessarily have that problem. These types of businesses don’t usually have their clientele reporting to the IRS how much they paid for their service. Additionally, the IRS is fully aware that you are receiving a large portion of your income in cash. Unfortunately, by the very nature of the business the IRS becomes more curious, and don’t think they can’t figure out about how much you make. People that are bringing in the money don’t tend to save it in their mattress.
The purpose of the list is not to scare you from taking deductions that you are rightfully due just to avoid an audit. In fact, it is the opposite. We all should be taking advantage of every tax deduction afforded us to lower our tax liability. My purpose in writing this article is to show you that you should be filing your tax return with these things in mind. Using a tax professional to help along the way may not decrease your chances of an audit, but it will increase your chances of winning that audit, should it come up. Day & Associates is here to make those decisions easy. Call us today and get the tools needed to save tax dollars tomorrow.