The 7 Mistakes That Could Trigger an IRS Audit
By Maryalene LaPonsie
Despite their reputation, I'm sure Internal Revenue Service agents are very nice people. I'm equally sure that I really don't want them knocking on my door and asking for my shoebox full of receipts. You might feel the same way.
Unfortunately, there's no surefire way to avoid an audit, but you can take comfort in knowing that less than 1 percent of taxpayers were audited in 2013. And you can further reduce your odds by avoiding some common mistakes that could trigger a visit from the taxman.
Mistake No. 1: Hiring the Wrong Tax Preparer
The first mistake you could make might occur before you even get your name on the tax return. It's picking the wrong tax preparer.
Select someone who is incompetent or unethical, and they could spell big trouble for you. If the IRS audits one of returns they filed and finds significant problems, they could decide to audit all the returns that person prepared for the year or the past several years. Don't make this mistake. Read our advice on how to select the best tax pro.
Mistake No. 2: Saying Your Hobby Is a Business
Let's say you breed and sell dogs or sell blankets on Etsy or resell garage sale purchases on eBay (EBAY). At the end of the year, you realize you spent more than you made and decide to deduct a loss from your "business" on your taxes.
The problem is that if you do that for three or more years, the IRS is going to get suspicious. A business is something that makes money. If you haven't made money in three years, you may have a hobby, and the IRS doesn't allow business deductions for hobbies.
Mistake No. 3: Filing Certain Schedules or Forms
You might say the third item on our list isn't a mistake because, in many cases, there is no way to avoid it. For example, if you have a business, you need to file a Schedule C. And yet filing a Schedule C increases your chances of an audit. However, it would be a mistake to file a Schedule C if you have an unprofitable business that is more like a hobby. It may also be a mistake to file a Form 5213 if you're not sure.
Form 5213 prevents the IRS from auditing you for the first five years of your business, and it is typically used when transitioning a hobby into a business. It allows you to claim losses from your hobby-turned-business, no questions asked. That is, until the five years are up, and the IRS comes calling to see what you've been up to.
Mistake No. 4: Taking Questionable Deductions or Credits
Under the category of questionable deductions, the two that may be most likely to raise red flags are excessive charitable contributions and a home office. Under the category of credits, the Earned Income Tax Credit is most likely to get you in trouble.
If you donate a large percentage of your income to charity, be sure to keep careful records. Too many contributions, relative to your income, could be a problem. Of course, you definitely want to claim every deduction you're entitled, but you might want to think twice about inflating the value of those items you dropped off at the thrift store. Keep careful records of all donations and be sure to get a written acknowledgement from a charity to which you donate $250 or more a year.
As for the home office, again, take the deduction if you're entitled, but be ready to defend it if needed. The most important thing to remember is you can only deduct a home office if you use that space exclusively for business. In other words, a communal family desk can't be considered a home office because it's used for purposes other than your work.
In 2013, the IRS came under fire in a report from the Treasury Inspector General for Tax Administration for not taking enough action to curtail improperly awarded Earned Income Tax Credits. In a statement reported by multiple news outlets (although apparently no longer on the IRS website), the agency fired back by saying EITC claims were twice as likely to be audited as other returns. If you claim the EITC, consider yourself warned.
Mistake No. 5: Claiming a Loss From a Rental
While the housing market may be on the rebound now, years of depressed (and depressing) prices may have led some to convert their old home into a rental rather than selling it. If you've done that and found the rent doesn't quite cover the mortgage and taxes, you may assume you're entitled to take a deduction for the losses.
Not so fast. You have to either be an active participant in the management of your rental or a real estate professional to do that. I could send you to a long and confusing IRS page for the details, but NOLO has a much easier to understand explanation. Make sure you're eligible to deduct the losses before doing so, particularly because rental owners seem to be a target for IRS audits.
Mistake No. 6: Failing to Claim All Your Income
The next mistake that can lead to an audit is thinking you can keep secrets from the IRS. You may think the government won't know about the money you earned freelancing on the side, but if the company you worked for files a 1099, the IRS knows.
You may think you can keep your alimony checks a secret, but if your spouse is reporting those payments on their return, the IRS knows.
You may think the interest you earn from foreign bank accounts is between you and that country's bankers, but if those nice bankers are sharing information with the United States, the IRS knows.
Don't take the chance of getting caught in a lie. Claim all your income, and then the IRS won't have any discrepancies to note and one less reason to flag your return for an audit.
Mistake No. 7: Making Math Errors
The last mistake on our list is also the simplest mistake to avoid. It's math errors.
If can't add and subtract correctly, the IRS may start wondering what else you got wrong in preparing your return. Avoid this audit trigger by using tax software or an online program that will virtually assure the calculations are correct. If you earn less than $60,000, you can find free online tax prep through the IRS Free File program.
Have you been on the receiving end of an audit? Was it a thing of nightmares or really no big deal? Tell us about your experience in the comments below or on the Money Talks News Facebook page.