Tax audits can be stressful for taxpayers and can cause them to wonder if they’re at risk of a tax audit. This is especially true if a taxpayer has a unique income stream or if they’ve been flagged for an audit in the past. There are some red flags though when it comes to filing taxes that can signal that a tax audit may be in your future.
If you have any of the following situations, you may be at risk of an audit.
Failing to report all income is the most common reason for an audit. The most common way this happens is when a taxpayer underreports their income from a side business. This includes income from self-employment, alimony, or income from rental properties. Often these amounts are hard to track and so it’s easy for taxpayers to forget to report them.
The IRS starts by looking at a taxpayer’s unexplained increase in wealth. If, for example, a taxpayer went from making $50,000 a year to $100,000 a year unexpectedly, they may be flagged for an audit.
Suspicious Home Office Deduction
A home office is one of the most common deductions for self-employed taxpayers.
Unfortunately, it’s also one of the most commonly claimed deductions that the IRS has flagged for an audit. If a taxpayer uses a portion of their home exclusively for business and then claims a home office deduction, it can raise a red flag for the IRS. The second red flag to be aware of with home office deductions is claiming a deduction for a home office when your business is based online. It’s more common for a business that’s based online to claim a home office deduction than a traditional brick-and-mortar business.
Earned a Lot of Money
A taxpayer that works as an independent contractor can have a huge year and make a lot of money. As a result, they may be flagged for an audit. The IRS won’t automatically flag a taxpayer that’s been reported on a regular basis and suddenly has a large spike in income.
If a taxpayer is a high earner, claims a large charitable contribution deduction, and has a relatively low tax liability, this could be a red flag for the IRS. A high income coupled with a high deductible expense could be a ticking time bomb for an audit.
Reported Business Losses
If a taxpayer has reported a loss for more than two years, the IRS may flag the taxpayer for an audit. This is especially true if the business is housed in their home. For example, a taxpayer that is working from home as a consultant should generally make a profit over the course of a year if they’re billing clients at their regular rate.
However, if the taxpayer is only reporting a loss, the IRS may investigate to see if there are unusual circumstances. Unusual circumstances would include an unusually high business loss because the taxpayer had to work for free or at a reduced rate.
Unusual Large Business Expenses
If a business incurs a large expense, it may make sense to claim it on its taxes. But those expenses should seem logical for the industry the business is in.
For example, it’s common for a construction business to spend a large sum on tools, scaffolding, and other construction materials. But if a business that is in a completely different industry, like a bakery, for example, claims a great deal on scrubs and uniforms for their employees, it may raise a red flag for the IRS. They’ll want to know if the business is really in the baking business or if they’re disguising their income as employees’ salaries.
A tax audit is a stressful time for taxpayers. If a taxpayer has a high income, then it’s possible that an audit could take a big bite out of their finances. As stressful as the process may be, it’s never a good idea to ignore an IRS bill or audit notification. That will only make things worse. Instead, the best course of action is to contact an accountant who can handle the audit for you.
Axiom Tax Resolution Group provides a tax resolution specialist who can help to negotiate and explain things to the tax auditors on your behalf, ensuring that there are no additional tax problems created. We’ll also work to help you with the appeals process. Let us provide the tax resolution you need to keep your financial future secure. Contact us today!