IRS audit: What red flags will trigger them and how to minimize them

The agency has an ongoing audit campaign involving the issue of when limited partners and LLC members in professional service industries owe self-employment tax on their distributive share of the firm’s income. We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag. If the deductions, losses, or credits on your return are disproportionately large compared with your income, the IRS may want to take a second look at your return. Taking a big loss from the sale of rental property or other investments can also spike the IRS’s curiosity.

Reporting too many losses on a Schedule C

If you’re telling the truth, and the whole truth, you needn’t worry. Nothing is inherently sinister about an IRS audit or state audit. However, people who are consciously cheating the system do have reason to be concerned. Profit and prosper with the best of Kiplinger’s advice on investing, taxes, retirement, personal finance and much more. The credit begins to phase out if your modified adjusted gross income (AGI) is above $400,000 on a joint return, or over $200,000 on a single or head-of-household return.

If you get such a letter, you can agree that the fault was yours and pay the bill (taxes, interest, and, in some cases, penalties), something you can decide yourself if the mistake is obvious and wholly yours. Or you can disagree and proceed to further examination of the specific items in contention (which may continue to be handled by correspondence or on the telephone). Every audit focuses on certain aspects of a return, but the kinds of records we request will most likely be on the following list. You must include the circumstances surrounding any document you send. Audits are one of the main tools the IRS has for clawing back money owed in taxes that has not been paid.

The IRS also targets heavy SUVs and large trucks used for business, especially those bought late in the year. That’s because these vehicles are eligible for more favorable depreciation and expensing write-offs. Schedule C is a treasure trove of tax deductions for self-employed people. But it’s also a gold mine for IRS agents, who know from experience that self-employed people sometimes claim excessive deductions and don’t report all their income.

• When no additional materials are needed and it’s been determined that you either owe a bit more or are owed a bit more in your tax refund, this is known as an adjustment letter.
• You can avoid going to the audit by hiring someone to go in your place.
• Sometimes an audit can be as simple as the IRS letting you know that a few more documents are needed to complete your return — known as a correspondence audit.
• Remember, it’s up to you to back up the information on your return.
• The more informed you are, the more prepared you will be if an audit occurs.

Receiving an audit notice can be daunting, but understanding what to do can make the process more manageable. Simple mistakes, such as arithmetic errors or omissions, can lead to an audit. Carefully review your return for mistakes before submitting it. Claiming more exemptions than you qualify for can be problematic. Review your filing status annually to ensure you’re compliant with tax regulations. Robert W. Wood is a tax lawyer () who handles tax disputes, writes tax opinions, advises on crypto, disclosures and more.

Not Reporting All of Your Income

If you disagree, you can ask for mediation to try and work things out, or you can speak to an IRS manager and perhaps convince them that the original agent’s estimation of the situation is wrong. You should keep all supporting tax documentation for six years just in case, but tax law requires that you keep it for irs audit at least three years. The IRS accepts electronically stored data in some cases, but you might want to keep paper copies for backup.

Operating a marijuana business

However, audits can vary based on factors such as income level and the complexity of your return. If you are selected for a field audit, it is highly advisable to have a tax professional with you. This ensures your rights are protected and helps prevent the audit from expanding to areas outside the original scope. An audit may result in no change to your return, a finding that you owe taxes, or even a finding that the IRS owes you a refund.

That is harsh, but the rule about the statute of limitations is even harsher. If you fail to file a required Form 5471, your entire tax return remains open for audit indefinitely. This override of the normal IRS statute of limitations is sweeping. The IRS not only has an indefinite period to examine and assess taxes on items relating to the missing Form 5471. The AOTC is worth up to $2,500 per student for each of the first four years of college.

In fact, the IRS can make any adjustments to the entire tax return with no expiration until the required Form 5471 is filed. Forms 5471 are not only required of U.S. shareholders in controlled foreign corporations. They are also required when a U.S. shareholder acquires stock resulting in 10% ownership in any foreign company. The harsh statute of limitation rule for Form 5471 was enacted in 2010, part of the same law that brought us FATCA, the Foreign Account Tax Compliance Act.

In-person audits, on the other hand, may take place at the taxpayer’s home or business. Understanding these distinctions can help demystify the audit process and reduce anxiety. The more informed you are, the more prepared you will be if an audit occurs. Taxpayers can also seek assistance from tax professionals who can provide guidance and support throughout the audit process, ensuring that they are not navigating it alone. Once you receive this, you will need to gather the necessary documentation to support your tax return. This can include receipts, bank statements, and any other relevant financial records.

Oddly, people who make less than $25,000 have a higher audit rate. This higher rate is because many of these taxpayers claim the earned income tax credit, and the IRS conducts many audits to ensure that the credit isn’t being claimed fraudulently. If you skip one of these forms, the IRS clock never even starts to run. Of course, the IRS also has no time limit if you never file a return. For unfiled tax returns, criminal violations or fraud, the IRS can take its time.

For instance, the IRS estimates it wrongly refunded $21.9 billion in earned income tax credits to taxpayers in fiscal year 2023…a 33.5% improper payment rate. The IRS attributes these erroneous payments in part to complexity in the tax rules, unscrupulous or incompetent preparers, the high turnover of taxpayers eligible to take the credit, and refund fraud. The IRS hasn’t always been diligent in pursuing individuals who don’t file required tax returns. In fact, the agency has been chastised by Treasury inspectors and lawmakers on its years-long lack of enforcement activity in this area. So, it shouldn’t come as a surprise that high-income non-filers now top the list of IRS’s strategic enforcement priorities. This applies only to taxpayers with total positive incomes of less than $400,000, meaning income before taking losses and deductions on their federal tax returns.