While it still feels very much like winter here in the Northeast, weather forecasters and the calendar assure us that Spring will, indeed, get here soon. With the arrival of the first robin in the front yard also comes a day that many Americans dread, or at the very least loathe: April 15, the deadline for filing Federal and state taxes. Tax season can be stressful under even the best of circumstances. Adding to the unease for many people is the possibility of an arbitrary investigation of their tax returns, known as an audit, that the IRS sometimes performs. While most Americans will fortunately never have to deal with the tax man showing up at their door, there are some well-established red flags that make certain returns more likely to be audited. I’ve listed 3 of the most common below; your tax professional or accountant can discuss the rest with you. (Don’t have an accountant? Give us a call…we can refer you to one of our many local and national tax attorneys or CPAs.)
A quick note: Historically, the IRS audits less than 1% of the tax returns it receives every year. Given the recent scandals, budget cuts and staff eliminations, it’s likely that that percentage will drop for the ~250 million returns the agency receives in 2014. The scenarios I discuss below are the ones that raise the the likelihood your lucky number will be chosen.
You might be more likely to face an IRS audit if you:
1. Earn a well-above-average income. The median household income in the United States is currently a little over $51,000 per year. If you’re a “one percenter” with an income over $200,000, you are about 3 times more likely than the average person to be audited by the IRS. If you make over $1 million per year, your chances of being audited go up to 1 in 8. Obviously, we’re not going to counsel you to earn less income! But if you’re in a higher income bracket, be aware that you face more scrutiny.
2. Claim excessive deductions on Schedule C. The IRS has been cracking down on self-employed taxpayers who over-report deductions on the Sole Proprietorship Profit and Loss form, otherwise known as Schedule C. This is due mostly to “paraprofessionals” like part-time real estate agents, day traders and others reporting rental and trading losses on Schedule C instead of the appropriate forms. We encourage honesty, obviously, but be wary that you might be paying for others’ sins if you are self-employed as a sole proprietor. Word from the wise, there is a fine line between tax avoidance and tax evasion – evasion however is still illegal.
3. Take a lot of charitable deductions. Auditors pay close attention to charitable deductions, and they specifically scrutinize how the amount of charity giving or gifting you report stacks up against your income. If there’s a large disparity, your return is more likely to spur unwanted interest. If you do a lot of charitable giving, understand the regulations, and relentlessly document everything.
These are just a few examples of the types of issues that can raise the likelihood of an IRS audit. As noted above, we’re happy to share our experience in this area with you, or refer you to a qualified CPA for more information.