Tax Tips Red Flags for the IRS
If you think finishing and submitting your taxes is tedious, just imagine what an audit would feel like! To help you avoid the IRS taking a deep dive into your finances for 2015, we've compiled the top characteristics shared among paperwork that's flagged for audit.
- Gambling. Whether Vegas or the derby, Uncle Sam wants his cut! Both recreational and professional gamblers must report their winnings to avoid IRS attention (remember the casino directly reports the amounts to the IRS so there’s no escaping it). Claiming large gambling losses can also be risky, as you can only deduct them to the extent you report the winnings.
- IRA Early Payout. An IRS sampling found that nearly 40% of individuals surveyed made errors on their income tax returns in regards to retirement payouts…they look at this issue closely, and special attention is given to payouts before age 59 1/2 (which are subject to a 10% penalty on top of regular income tax).
- Business Meals. That Michelin Star dinner’s totally on Uncle Sam, right?! Tread lightly as the IRS isn’t exactly a fan of mixing business with pleasure. Tedious (but worth it): 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 to qualify for deductions. Without proper documentation, your deduction is toast! (and not that fancy kind @ Mario Batali's you already wrote off).
- Charitable Donations. Proof no good deed goes unpunished! If your heart strings were tugged and you reached a little deeper into those pockets make sure it’s all properly documented…keep in mind the IRS knows what the average charitable donation is comparative to your income level.
- Owning your own business. Being your own boss sounds so…well, boss…but it can actually send off warning signals, especially if you’re not generating much income but claim your home office and other costs as business expenses.
- Big earnings. While you should be able to enjoy the fruits of your labour, the higher the earnings the higher the audit risk, so be meticulous about your record keeping!
- Not reporting all of your income. The IRS automatically receives copies of all the 1099s and W-2s you receive, so there’s no pulling the wool over their eyes! A mismatch between what you’ve reported and what their computers have on file will result in you being handed a bill.
- Claiming day-trading or business losses on Schedule C. Hey ya win some ya lose some, but if you’ve had your business for 3 years and are still reporting a loss (sigh), your audit potential increases…especially if you used a Schedule C to claim your losses rather than incorporating.
- Losing or forgetting to file a form. Employers send copies of all 1099 and W-2 forms to the IRS as well as to you, so if you lose your version or forget to file it with your taxes your return will most likely be flagged for review.
- Claiming losses for rental properties. The IRS began its real estate professional audit project a few years ago, and this successful program continues to bear fruit…so don’t be the sour grape! Make sure you’ve worked the necessary hours (especially in cases of landlords whose day jobs are not in the real estate business) to qualify as a “real estate pro” and be able to claim losses.
- Foreign bank accounts. Unless you’re Jordan Belfort you probably don’t have multiple offshore accounts in the Caymans, but if you do be aware the IRS is intensely interested in people with money stashed outside the U.S. Failure to report a foreign bank account can lead to severe penalties, so make sure to properly report them with FinCen Form 114 and IRS Form 8938.
- Major income shifts. Hey in this day and age one day you’re ridin high and the next a little lower, but any significant increase or decrease in income will raise red flags!
- Claiming a home office deduction. Checking an email from Cindy at work on your couch does not a home office make! In order to qualify, the “office” portion of your house must be used for work purposes only.
- Too many deductions. While there’s no reason to ever pay the IRS more than you actually owe, if you claim deductions that are disproportionally large compared with your income the IRS may pull your return for review.
- Taking a deduction for alimony payments. They say breaking up is hard to do, so why make it even harder by claiming this write-off if you don’t satisfy the necessary requirements? First off, alimony does not include child support or non cash property settlements, and payments can only be made under a divorce, separate maintenance decree, or written separation agreement. A mismatch in reporting by the payer and recipient almost always triggers an audit, so unless you can’t wait to be back in the courtroom with your ex again, make sure your returns align!
- Type-os or entry errors. Treat your taxes like a final exam in algebra and check your work before submitting. No you’re not back in grade school - if your numbers don’t match what the IRS has on file an alarm will be raised, so accuracy is key!
- Claiming 100% business use of a vehicle. You totally needed that new Porsche Spyder strictly for work purposes, right?! Tread (get it) lightly - the IRS knows it’s rare for someone to actually use a vehicle 100% of the time for business, especially if no other car’s available for personal use. If you’re making the claim, keep detailed mileage logs and precise calendar entries for the purpose of every road trip.
- Writing losses for a hobby, not a business. Breeding the next Black Beauty or Seabiscuit? What a cool hobby! Just make sure you’re not writing off any losses as that veers into illegal territory (and you’re gonna be far too busy riding off into the sunset on your noble steed for that). To be eligible to deduct a loss you must be running the activity in a business-like manner and have a reasonable expectation of making a profit.
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