How to Navigate an Individual Tax Audit
Summary: No one enjoys a tax audit, and there’s no way to guarantee that you won’t get hit with one. But there are some things you can do to minimize the chances of being audited by the IRS. Click through for some tips that can help you either avoid an audit or, at the bare minimum, survive an audit with as minimal chaos as possible.
While it is accurate to say that the IRS has audited significantly fewer people, less than 1% of individual tax returns are audited and the majority of audits nowadays are handled from a distance rather than in person, these changes do not mean that you will never be selected by the IRS for an in-person audit of your tax forms.
How to prevent an audit from the IRS
So, what are key warning signs that you can look out for if you want to decrease the odds of attracting unwanted attention from the IRS? Here are seven actions that you must avoid when you file your taxes every year:
- Refraining from reporting all your taxable income streams: If there is any sort of discrepancy between what you claim as income compared to what the IRS computes by cross-checking 1099 or W-2 forms, then the IRS will likely have questions for you. Even if you have not received a 1099 for work that you performed, whether that is dog walking, driving for a rideshare company or offering music lessons, the money you received from these endeavors is taxable, meaning it must be reported come tax time.
- Receiving large paychecks: The odds of you being audited rises as your income increases. People who are rather wealthy will often receive additional scrutiny from the IRS.
- Claiming deductions, losses or credits that are disproportionate or questionable: If you claim deductions, losses or credits that end up being disproportionately lofty in comparison to your reported income, the IRS will likely look more closely at your tax return in an effort to understand the circumstances.
- Filing for significant deductions under the guise of charitable donations: Your charitable donations and deductions must be proportional to your income. The IRS has knowledge pertaining to what the average charitable donation is for you in regard to your income level, so if you make claims that surpass what is reasonable or realistic, the IRS will be concerned about how much of an outlier your claim appears to be. Make sure you have receipts for both cash and digital contributions that you made during the tax year so that you can show your documentation to the IRS should you be selected for an audit.
- Reporting repeated losses as part of your Schedule C form: To the IRS, your income may appear to be stemming from a hobby, and hobby losses are often litigated in Tax Court. The IRS may assume that you are reporting these losses as part of your Schedule C form in an effort to offset your wages or other income, such as money that comes in from investments. Be mindful of this come tax time.
- Withdrawing from IRAs or 401(k) accounts too early: You must make sure you adequately and accurately report any distributions received from an IRA or 401(k) as well as pay tax on said distributions. Special attention is given to payouts that are received before you reach the age of 59 1/2, which, except for situations where exceptions apply, could subject you to a 10% penalty in addition to having to pay regular income tax. According to a 2015 review, about 40% of people made errors regarding retirement account payouts on their income tax returns, so the IRS pays extra close attention to this issue as it is incredibly common.
- Inaccurately documenting your alimony payments: Failing to properly denote the value of alimony payments will almost always trigger an audit by the IRS. Both the person paying the alimony and the individual receiving it must report each and every payment on their respective tax returns. Also, keep in mind that there have been changes to how alimony is taxed, so the IRS is taking measures to closely police and monitor compliance with the new alimony tax laws. Schedule 1 of Form 1040 states that if you choose to deduct alimony payments or report alimony as income, you must include the date of the divorce or separation agreement that denoted alimony as a requirement of such a circumstance.
Mistakes related to math or numbers, such as accidentally inputting a three instead of an eight or unintentionally failing to add a zero where necessary, can cause the IRS to look more closely at your tax forms. Choosing to round up your numbers instead of including the exact digits can raise red flags as well.
Stop yourself from making estimations or raising values to the nearest dollar. If you are not as accurate as possible, you could end up having to pay significant fines if you engage in this type of behavior, no matter if your mistake was intentional or accidental. Generally speaking, the IRS might come across these problems when agents are merely double-checking your numbers when ensuring there are no discrepancies within your return.
None of the aforementioned details suggest that you should avoid claiming credits or deductions that you are legitimately entitled to for the sake of ensuring you will avoid an audit from the IRS. Rather, hire a qualified tax professional who can help you ensure that you are in compliance with the rules of the IRS. Always keep proof of your claims and hold onto copies of documentation that support the information within your tax return.
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