In 2016, the Internal Revenue Service audited one million tax returns. Although this is less than one percent of the U.S. population, you should still be prepared – just in case you’re audited.
Want to know what might trigger an audit by the IRS? Here are 9 red flags that might elevate your chances of having to undergo this unpleasant process. Take a look:
You Make a Ton of Money
Even though the overall odds of a tax audit are small, they increase as you start earning more money. IRS data shows that in 2016, those with reported income over $200,000 were audited at a rate of 1.70 percent. That’s one out of every 59 taxpayers. Do you earn more than one million dollars a year? Your chance of an audit goes up even more. According to Kiplinger, one out of every 17 people earning $1 million or more were audited in 2016.
Did You Forget to File a Form?
Each year you should receive a W-2 from your employer. You should also receive 1099s from any companies which paid you $600 or more. To further explain, 1099s are for independent contract work and you are responsible for claiming taxes on these amounts. Copies of both your 1099s and W-2 forms are also sent to the IRS. So, if you forget to file these forms and claim the associated income, this can be a major red flag as the IRS knows what you earned.
Another thing to put on your to-do list: make sure your correct income is listed on your forms. And, if you find an inaccuracy, talk to your employer or client and make sure you get it corrected. This way, both you and the government receive the right information.
Make Sure You Document All of Your Deductions
The IRS doesn’t have the manpower to audit every taxpayer. Instead, the agency is strategic and looks for anything that stands out from the normal. Some of the things that can catch the attention of the IRS include deducting a large charitable donation or taking a massive loss on a rental property that required a lot of repairs.
In instances like these, it’s important that you document each deduction thoroughly. And, something else to keep in mind: because of the large increase in the standard deduction in 2018 (due to the Tax Cuts and Jobs Act), fewer people will likely be itemizing deductions. This may also mean that your itemized deductions may stand out as a red flag to an IRS representative.
You Claim Alimony
If you received or made alimony payments in 2017, this amount is calculated as part of your taxable income. If you are the one making the payments, the amount you paid to your ex-spouse is usually a deductible expense – as long as certain requirements are met. But the IRS is on the look-out for filers who claim this deduction when they don’t meet the requirements set forth in their divorce decrees.
It’s important to also note, however, that things are changing in 2018. As part of the latest tax reform, this deduction has been eliminated and after December 31, 2018, alimony paid will no longer be deductible on your tax return.
You Are Self-Employed
If you are a small business owner who works from home or if you have a side hustle, your chances of an audit may go up. Why? The IRS has a tendency to get a little suspicious if you’re claiming a home office in addition to other expenses. If you fall into this category, make sure you keep excellent records and save all receipts for your business.
You Take a Loss From a Hobby
Any income that you generate from a hobby must be reported on your tax return. Plus, you are allowed to deduct any expenses that you incurred. However, it begins to get a bit murky if you attempt to write off a loss – from a hobby that isn’t a bonafide business.
You’re Deducting Business Meals and Entertainment
If you are a business owner, there is a good chance you take clients out to eat, to sporting events, or maybe even concerts. It’s typically part of doing business. However, the IRS gets suspicious when it notices large write-offs coming from meals and entertainment.
You Have Gambling Winnings or Losses
The next time you take a trip to the casino or horse track and win big, make sure you understand that Uncle Sam will want his cut. And, if you fail to report the money you win from gambling, this can throw up a big red flag.
The same goes if you deduct large gambling losses. You can only deduct the losses up to the amount of your actual gambling winnings. For example, let’s assume that throughout the year you had $1,000 in winnings from poker. Unfortunately, you also had losses that totaled $1,500. You would only be allowed to claim a loss of $1,000.
You Take an Early Withdrawal from a 401(k) or IRA
While it’s acceptable to take an early withdrawal from your 401(k) or IRA, it doesn’t come free. When you withdraw funds from a retirement account before the age of 59 ½, you’ll generally need to pay a 10 percent penalty – in addition to income taxes on the amount withdrawn. There are, however, certain exceptions to this rule, so make sure you thoroughly understand the pros and cons before withdrawing funds from your retirement plan.