Ernie Neve, CPA
March 10, 2020
Like the title says, there might not be anything worse than hearing or reading those words from the IRS – the ones telling you to prepare for an audit.
Even after all of these years, I still get nervous hearing them, but, having “been to the movie” a few times, I’ve learned that most audits are prompted by a few specific actions on the part of the taxpayer and their preparers.
Before we look at the red flags that can cause an audit, let’s take a minute to remember this – most audits of personal returns are done by mail – asking a taxpayer to clarify a point on their return, or simply asking for more documentation.
Those are the “easy” ones and, honestly, sometimes, it’s simply a matter of not having reported something – a minor change to your AGI – and my advice is usually to simply acknowledge and pay the difference.
On the other hand, there are those face-to-face audits that can really cause some trauma and drama. Here are some of the things that will get them to knock on your door … and remember, any tax professional that won’t stand with you and defend their numbers in front of the IRS is NOT the one you need on your team.
· By far, the biggest red flag to the IRS is making a lot of money. We’ve all seen the figures – the average American makes about $45,000 annually, so high rollers are going to be audited. The IRS is not looking to spend its time and resources to debate if your $27 donation was actually deductible, but you can bet they’d like to know about high net-worth individuals, especially those with multiple entities and Roth-based accounts. (It’s worth noting, though, that in a time when so many politicians focus on the “1%” of the world that is “rich” the facts are if you make over $499,000 a year, YOU are in the “1%”…
· Not claiming all your income. It seems ironic that the IRS allows us to “do” our own taxes, yet has all of our income information, be that through a W-2, 1099, or 1095. Nonetheless, the majority of audits are generated when taxpayers don’t claim all their income for the year. This is why you have to really make sure you keep track of where the money comes from – especially if you’re self-employed and receive 1099’s as a contractor.
· If your deductions are proportionally higher than most taxpayers, you can expect the IRS to check you out. This is a fine line to walk – if all your numbers are accurate, then claim everything you can. If, however, you might have incorrectly added or subtracted something, then make sure before you file. I remember several years ago, a new business owner had claimed over 20,000 business miles on his vehicle – and that, coupled with his low start-up income – caused questions to be asked. He had everything documented, though, so there were no problems with his return. Always make sure…
· Donating a large sum to a charity. Everybody likes giving something back, but the challenge is that, no matter how motivated you are, the IRS knows what the average taxpayer is giving to charities every year. Like the deductions we just talked about, a big donation is going to cause questions to be asked, so if you did, in fact, send in a substantially larger amount than the $500 allowed, good for you. Just make sure you have the documentation to prove it.
· If you play fast and loose with rental losses, especially if you claim to be a real estate expert, you can plan on explaining that to the IRS. It’s really that simple. You can expect to be required to prove how much time you spent actively managing the properties with a loss and, if you’re under the $100K AGI threshold and still work full time somewhere else, you might be in for a long day with the IRS.
· Schedule C deductions are always a target for the IRS, especially if you are running a business with primarily cash-based receipts. Expect to be checked on if you’ve bought a bigger SUV or truck due to the depreciation schedules on them OR if you claim a vehicle is only for business use. In short, you need to make sure your Schedule C information is 100% accurate because it is always a target.
There are at least a half dozen others I can think of, but these really “popped” today. As you can see, most of them can be defended if you are dedicated to good record-keeping. On the other hand, if you’ve got everything crammed in a shoebox, it’s hard to not get pinched.
As always, if you have any questions OR the IRS has contacted you, it’s imperative to reach out to me and the team so we can make sure you’ve got all your information ready to win.
All the best-