IRS Audit Triggers: Six Red Flags

Ever wonder why some tax returns are scrutinized by the Internal Revenue Service while most are ignored? The IRS audits only slightly more than 1 percent of all individual tax returns annually. The agency doesn't have enough personnel and resources to examine each and every tax return filed during a year. And its resources are shrinking ... the number of enforcement staff dropped nearly 6 percent last year, partly due to budget cuts. So the odds are pretty low that your return will be picked for review. And, of course, the only reason filers should worry about an audit is if they are fudging on their taxes.
Here are six red flags that could increase your chances of drawing some unwanted attention:
We're not saying you should try to make less money -- everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you'll be hearing from the IRS.
That's because IRS computers know what the average charitable donation is for folks at your income level. Also, if you don't get an appraisal for donations of valuable property, or if you fail to file Form 8283 for donations over $500, the chances of audit increase. And if you've donated a conservation easement to a charity, chances are good that you'll hear from the IRS. Be sure to keep all your supporting documents, including receipts for cash and property contributions made during the year, and abide by the documentation rules. And attach Form 8283 if required.
A second exception applies to real estate professionals who spend more than 50% of their working hours and 750 or more hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation. But the IRS is scrutinizing rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. The agency will check to see whether they worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business.
Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don't satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.
You must report any income you earn from a hobby, and you can deduct expenses up to the level of that income. But the law bans writing off losses from a hobby. For you to claim a loss, your activity must be entered into and conducted with the reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes that you're in business to make a profit, unless IRS establishes otherwise. If you're audited, the IRS is going to make you prove you have a legitimate business and not a hobby. So make sure you run your activity in a businesslike manner and can provide supporting documents for all expenses.
See six more IRS Audit Red Flags on Kiplinger
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