Be it business or personal taxes; there’s always a risk of a tax audit by the IRS
According to the IRS, people with higher incomes typically undergo more audits. For instance, individuals with an income higher than one million dollars had more audits than individuals earning less. Why does the IRS target high incomes? Individuals who make a lot of money generally have more complex taxes—the more sophisticated the tax return, the greater the chance for errors or fraud.
However, you could earn $50,000 and still get audited by the IRS if the agency believes you misreported income. A tax audit will delay your return and may lead to fines.
Before diving into factors that cause an audit, it’s essential to understand the difference between tax evasion and tax avoidance. Individuals commit tax evasion when they misstate or hide information to avoid paying taxes.
Tax evasion comes with hefty penalties, including steep fines and jail time. On the other hand, tax avoidance is a legal strategy employed by companies and individuals who want to pay less in taxes using legal methods. For example, donating to charity is a way that you can lower your taxable income.
You can’t always avoid an audit, no matter how honest you are. However, you can be mindful of a few red flags that could trigger the IRS to audit your taxes:
Remote work has become the new norm for millions of Americans ever since the COVID-19 pandemic. The IRS doesn’t allow you to deduct work-from-home expenses if you’re a W-2 employee. You can’t deduct one-thirds of your rent because you work out of your bedroom. The IRS allows you to use the home office deduction if you’re a 1099 contractor or own a business. You can only use your home office for work-related matters (no multi-tasking). If you claim a home office deduction, there’s a chance the IRS may audit you.
Numbers – precisely rounded numbers – often look fishy in the eyes of the IRS. The IRS will assume that you’re using estimates or falsifying numbers. If you own a business, you should keep track of your finances using accounting software. Moreover, almost no company would have income and expenses that all end in zero or are round dollar amounts.
In this scenario, you may be wondering what to expect during an IRS tax audit. The IRS will likely ask you for proof of income (i.e., receipts) and expenses to reconcile the amounts to your tax return.
Another one of our tips for preventing a tax audit is understanding the concerns of overseas bank accounts. There’s nothing wrong with holding money in a foreign bank account unless you’re doing business with a sanctioned company. Nevertheless, you must file an FBAR if you have at least $10,000 in a foreign bank account. You’ll also need to report the interest income you made on any overseas balances.
If you have made errors in the past, you probably know what to expect during an IRS tax audit. For instance, if the IRS found you guilty of fraud evasion in the past, the agency will take a closer look at your tax returns. The IRS has your entire tax history and will be keen to audit you if they find anomalies on your return. Many people recommend working with a tax professional, such as a CPA when giving tips for preventing a tax audit. A professional is an advisor that helps you ensure you’re not taking any shortcuts when it comes to your taxes.
The last item on our list of red flags that could trigger a tax audit is charitable giving. The IRS currently lets you deduct up to 60 percent of your adjusted gross income as donations. You should always keep records of your donations, regardless of the amount. Significant contributions tend to trigger an audit, and the IRS will ask you for proof of your charitable acts.