These tax moves are most likely to trigger an audit

We all want to keep as much money in our pockets as possible, but it's also important to know where to draw the line when it comes to pursuing deductions and other efforts that might lower your annual tax burden. Keep in mind that certain deductions and other information on a tax return may generate an extra review from the IRS, if not an actual audit. Here's what finance experts had to say about tax returns most likely to cause the IRS to consider an audit.

Schedule C Income and Expenses

An IRS Schedule C is used to report the income and expenses of self-employed individuals, and often self-employed individuals fail to report all of their income, particularly cash-based transactions, says Lee Reams of the tax professional directory service TaxBuzz. "The IRS has studied various types of businesses to determine what percentage of total sales should be cash transactions. Thus, the IRS knows about how much a self-employed person's gross income for the year should be," Reams said. In addition, self-employed individuals often don't realize that credit and debit card companies report the total dollar amount of all transactions to the IRS via a form 1099-K, Reams adds. In other words, if the income reported to the IRS is significantly lower than the transactions credit and debit card companies report, an audit may be on the horizon.

Excessive Deductions

Excessive deductions will quite often trigger audits, particularly those that appear out of line or above the norm for an individual's income bracket, says Reams of TaxBuzz. These often turn up under the medical expenses tax deduction, charitable contribution deduction, or even gambling loss deductions. Some medical expenses, for instance, are partly tax-deductible. Under the current tax law, taxpayers are allowed to deduct qualified unreimbursed medical expenses that are above and beyond 7.5% of one's adjusted gross income. But taxpayers need to be careful not to go crazy with such deductions. Similarly, the IRS allows a deduction for money and property contributions made to qualified charitable organizations. You'll want to make sure that the contributions being claimed are reasonable and in line with your tax filing history.

Home Office Deduction

The home office deduction has always been a questionable deduction despite the fact that more people than ever work from home, says Paul Miller, CPA and founder of Miller & Co. "Eventually the IRS will have to revisit this deduction, but if you take it, you should definitely be prepared to support it," said Miller. Those who use part of their home regularly and exclusively for business can write-off such things as mortgage interest, insurance, utilities, repairs, and other expenses tied to the business space under the home office deduction.

Alimony Deductions

With the adoption of the Tax Cuts and Jobs Act, alimony payments resulting from any divorce or separation agreements made after Dec. 31, 2018 are no longer deductible. However, alimony payments tied to divorce or separation agreements that were settled before the 2018 deadline are still deductible by the payer. But don't try to fool the IRS and claim the deduction if your divorce or separation took place too late. While it may not trigger an all-out audit, it will likely raise some questions. "If you were deducting it previously … or just started in 2018, don't be surprised if the IRS wants to see your divorce agreement," Miller cautioned.

Schedule E - Rental Property Expenses

The adoption of the Tax Cuts and Jobs Act increased the standard deduction so much that for most taxpayers it no longer makes sense to itemize deductions. Those who do still itemize will want to make sure they have documentation for everything. This includes rental property owners who typically file a Schedule E to report income and losses from the property. "Now more than ever, if you're a sole proprietor, Schedule C or have a Schedule E rental property, the chances of your expenses being scrubbed by the IRS are much higher," Miller said.

Higher Income Taxpayers

Having a substantial annual income certainly has its perks. However, it may also have a few drawbacks. TaxBuzz's Reams says IRS Statistics of Income reports related to its audit activities show that audits increase as the taxpayer's income gets higher. "In other words, the IRS audits higher income taxpayers more frequently," Reams said. In fact, last year the IRS audited about 1% of those who brought in less than $200,000. But the audit rate for those earning more than $200,000 was almost 4%, and for those earning $1 million or more, the audit rate was a steep 12.5%.

Consistently Reporting Losses

Some taxpayers report business losses year after year, and after a while this will trigger the IRS' attention, particularly when one's home mortgage interest and taxes are reflective of higher income, Reams says. "If audited under these circumstances, the individual will generally need to show other sources of funds such as gifts, savings, loans, or tax-free income," Reams said.

Holding Assets in Foreign Accounts

There are now strict requirements regarding reporting assets held in foreign bank accounts, which was not the case in the past. As part of the Foreign Account Tax Compliance Act, taxpayers must report any assets valued at $50,000 or more in a foreign account. The law has created a somewhat dicey situation for taxpayers with foreign accounts. Now filers must reveal the highest dollar amount held in such an account during the previous year. The new openness mandated by the law is, by some accounts, more likely to trigger an audit, while ignoring the law can translate into significant penalties.

Excessive Business Travel Expenses

Similar to the excessive medical, charitable-giving or gambling deductions mentioned already by Reams, the IRS does not take kindly to those who claim unusually steep business travel expenses. In fact, the IRS relies on occupational tax codes to determine the typical level of travel for a given profession. If the claims on your return are 20% or more than what's typical, be prepared for a potential grilling by the IRS.

Not Reporting 1099 Income, Distributions from College Savings Accounts and More

We all have busy lives, and it can be hard to stay on top of all the paperwork required for your tax returns or remember all of the income sources you're required to report. Some of the documents and income often overlooked by taxpayers include statements from old brokerage accounts, or perhaps money pulled from a college savings account in order to pay tuition. Keep in mind that the IRS receives information regarding all of these things. If the IRS doesn't see them on your tax return, it will raise questions and likely trigger a letter audit.

Submitting Round Numbers

It doesn't matter if you're trying to deduct mileage, supplies, charitable donations, or your mortgage interest: Close doesn't count. Keep your receipts and billing statements, calculate the numbers down to the last cent and submit that. Just because the threshold for a deduction is a round number doesn't mean you can just round right up to it.

Deviating from the Norm

The IRS freely admits that it needs only a single anomaly to audit a return. Sometimes, audits are based solely on a statistical formula that your return had the misfortune of deviating from. The IRS develops those "norms" from audits of a statistically valid random sample of returns, as part of the National Research Program the IRS conducts. Basically, even some minor, unexplained glitch in your return can trigger an audit.

Not Filing at All

The IRS is certainly going to want a word with you if you don't even bother to file a return — the bare minimum you have to do at tax season. What's more, if you owe the IRS and don't pay, you'll be slapped with both late payment and late filing penalties that will add up. Even if you owe nothing or have no income, file anyway.

Advertisement