Tax season is the worst time of the year for many people. It’s a time when most individuals and business are required by the IRS to get their books to see if they have paid Uncle Sam enough money during the previous year or if they are going to be writing him a check come April 15.
One of the biggest reasons why so many people worry about their taxes is because of the potential for a tax audit. While this can be a fairly stressful event because the IRS will be digging deep into your finances, a tax audit only happened to roughly 0.4% of all individual tax returns filed in 2014.
To make sure that you are not part of that statistic when you file your 2015 tax return here are a few of the top IRS tax audit red flags to avoid.
You Have Been Audited Before
Unfortunately, if you have been audited by the IRS once, there is a much greater chance that they will do it again in the future. Because of this, it is extremely important that you are extra careful when preparing your tax return. The less attention you create for yourself, the better.
You Made A Lot Of Money
Making a lot of money any year is usually looked upon as being a good thing. However, it will draw the attention from the IRS. While the percentage of total tax audits might have been below 1%, the rate increases as you make more money. For those that made between $200,000 and $500,000 the rate of tax audits was 2.06%. And for anyone that made $10 million or more the chances of a tax audit was a staggering 24.16%.
You Write Off a Loss From Your Hobby
Any income that you earn from a hobby must be reported to the IRS. And just like any business your expenses can also be deducted at the end of the year. The tax law states that you are unable to claim a loss from anything that is considered a hobby. For you to claim any amount of loss you need to prove that you have been running this hobby as a business. The best way is to have earned a profit in prior years.
Taking an Early Withdrawal From Your IRA or 401k
When you withdrawal money from an IRA or 401k before you reach 59 and a half-years-old, you are required to pay an early withdrawal penalty of 10%. There are a few exemptions to this penalty, and this is where a lot of people get confused and then flagged. If you don’t meet one of the stated exceptions, then you are required to pay the early withdrawal penalty.
Claiming a Home Office Deduction For Your Business
If you are claiming a home office expense on your tax return and your Schedule C shows a loss on the business, then you are at a greater risk for an audit. If you do qualify for a home office deduction, then you can claim a percentage of your rent/mortgage, insurance, utilities, real estate taxes, and any other costs that it might take to maintain the home office.
There is a simple deduction method that can be used as well. You can deduct $5 per square foot that is used. It’s important to remember that this space must be used solely as a home office. If you have a desk in a guest room where people sleep, then this would not qualify.
Claiming Your Vehicle Was Used For Business 100% Of The Time
If you claim a vehicle was used for business purposes 100% of the time, then it will be a big red flag for the IRS. Make sure you keep a detailed record of the mileage that was used for the business and what was used for personal use. This will be a big help if the IRS agent comes asking for it.
Filing an Alimony Deduction
Any alimony that is received is taxable income and alimony paid is deductible if paid by cash or check and specific requirements have been met. The requirements are fairly complex, and IRS officials know that a lot of individuals will be claiming this deduction even though they have not met all of the requirements.
Giving Away A Lot Of Money
It’s always good to make charitable contributions each year, but if you are giving away a significant part of your yearly income, then this is going to be a big red flag. If you claim a deduction over $500, you need to make sure that you have the item appraised. If you don’t, then this can cause a tax audit. The IRS knows the average amount donated for each income level. If you are claiming more than that amount, there is a good chance they will want to take a deeper looking at you.
You Don’t Report All Taxable Income
If you have received a W-2 or 1099, then the IRS has received the same form. If you fail to report all of your taxable income, then the IRS will know about it and require you to pay taxes on the income.
Deducting Business Meals, Entertainment or Travel
If you run your own business, then it is highly likely that you need to travel to see clients or treat them to a meal if they are in town. Those expenses are deductible. The problem comes when those expenses are higher than what would be expected for the business.
The Bottom Line
The number of individuals that are selected for a tax audit each year is typically less than 1%. Avoiding these ten red flags will help keep you in good standing with the IRS.
Source: Investopedia