Tax Issues
What Might Increase The Chances of Your Return Being Audited By the IRS?
Risk of audit should not keep someone from taking legitimate deductions
- Keep receipts and good records
If you get a letter from the IRS assessing additional taxes, don’t just assume they are right.
- Chances are, you just need to provide additional information
- Review your records and compare it to the adjustments in the letter
- Seek help from a tax professional
Income level
- IRS overall audit rate is about 1.11% - Chances of being audited are very
low unless egregious mistakes are made
- If income is over $200,000, chance of audit increases to 3.93% or about one
out of every 25 returns
- If income is under $200,000, chance of audit decreases to 1.02%
- Income over $1 million, 1 in 8 chance of return being audited
Underreporting
- All W-2s and 1099s are sent to IRS. Their computers easily check to see if
you reported what was reported to them under your social security number.
A mismatch will generate an automatic letter assessing additional taxes,
including interest and penalties
Large charitable donations
- Large charitable donations disproportionate to income is likely to draw
attention to a tax return
- In a Dec 15, 2011 article on MSNBC, 24/7 Wall St. reviewed IRS data and
came up with the 10 most charitable states
- Utah ranks #1
Home office deduction
IRS has traditionally been successful in disallowing home office deductions for numerous reasons:
- Inadequate documentation
- Home office is not principal place of business
- Home office is not exclusively used for business
- Mortgage interest and real estate taxes, two biggest portions of home office
deduction usually deductible as itemized deductions
- May be a better write-off for renters
Deducting rental losses
- Can deduct up to $25,000 of rental losses if:
- Adjusted Gross Income is < $100,000 (phases out between $100k and
$150k)
- Actively participate in the renting of your property (can’t have somebody
else manage your property)
- Exceptions for real estate professionals
Reporting business income and expenses on Schedule C or Form 2106 (Unreimbursed Employee Business Expenses)
- IRS has most success auditing this form
- Sole-proprietors often make mistakes in understanding legitimated
eductions and in keeping adequate records
- Business meals, travel, and entertainment
- If amount seems too high for the business, IRS may take notice
- Deducting 100% of business use of vehicle
- Most taxpayers who use their car for business purposes don'’t keep a
mileage log
- IRS says log must be “contemporaneous” – this means you can’t make it
up after-the-fact
- Commuting doesn'’t count toward business mileage
- Large losses on Schedule C
- Especially if multiple years of large losses
- IRS may consider activity a “hobby”, unless:
- Must have profit motive
- Activity is presumed to be “for-profit” if gross income exceeds
deductions for 3 or more out of 5 consecutive years
- Facts and circumstances test:
- Manner in which taxpayer carries on business
- Expertise of taxpayer or advisors
- Time and effort spent on activity
- Expectation assets used will appreciate in value
- Taxpayer’s success in other business activities
- Taxpayer’s history of income/loss with respect to activity
- Amount of occasional profits, if any
- Financial status of taxpayer
- Elements of personal pleasure or recreation
- If “hobby”, must claim all income from activity and expenses are limited
to amount of income collected – can’t generate losses
