Like many other government agencies, the IRS has been hit by budget cuts. Only 0.7% of the almost 150 million tax returns from last year were audited. As a result, auditors target certain items and scrutinize them even more than ever before. When it comes to IRS red flags, here are a few items that might get you audited in 2017.
IRS Red Flags
Charitable Donations - Donating money to charities you believe in is fantastic. Don't stop doing that. But one of the most glaring IRS red flags comes from large charitable donations for a single individual. Make sure you can provide proof of these donations or else they could be disregarded in an IRS audit.
Hobby Losses - Another one of the IRS red flags that could get you audited is if you claim "hobby losses". In other words, you start up a "business" that you know you will not profit from simply to use it as a loss against wages earned in other capacities. Common "hobby loss" businesses include dog grooming, raising horses, racing cars, etc. If these were legitimate businesses and not a way for you to reduce your tax debt, run it like a business. When the IRS sends you a notice of inquiry, respond right away. Provide a mission statement. Show them your income and expense reports. Provide a profit and loss statement. If you run your business like a business, the IRS might decide not to audit you after all. On the other hand, if you hesitate to respond or fail to provide sufficient proof that your business is an actual business, expect to be called in to speak with an agent one-on-one.
Mortgage Interest Deductions - While you currently are allowed to deduct the interest on your mortgage, a large deduction could send up one of the IRS red flags. Make sure you have proof to back up any large deduction.
529 College Savings Plan - You're being a responsible parent. You set up a 529 College Savings Plan to insure your child's continuing education in the future. However, if you have made excessive contributions into this plan, it could send up another IRS red flag. Since it will not be taxed when used, wealthier individuals might use this to stash money away from the IRS. Thus, the red flag.
How to Avoid a Tax Audit
Double/Triple Check Your Numbers - Filing taxes is not a race. Take your time. Double check your numbers. Most importantly, make sure all social security numbers, number of dependents and the spelling of names on the return are accurate. One mistake, even a small one, could flag you for an audit.
Don't Get "Creative" - Honesty really is the best policy when it comes to your tax return. Be truthful with your deductions, income and any credits you report. When you are totally honest, the tax man won't have any reason to audit you.
Be Realistic - The tax code allows for many legitimate deductions. Have a home office? You could be entitled to several home office deductions. Talk to your tax person to find out what those might be. Don't go overboard, though. That's when you signal the IRS to check things out in more detail.
E-File - The IRS reports that electronic filing reduces errors by more than 20% from paper filing. The less mistakes you make, the less likely you are to get flagged for an audit.
Always check with your CPA, tax attorney or certified tax preparer to make sure you follow the law. Tax codes can be complicated and change often. They should be up-to-date on the latest tax laws. Remember...even when someone else puts together your tax return for you, you are the one ultimately responsible for your return.