What Are IRS Red Flags For Audit?
The IRS Red Flags uses a combination of automated and human processes to choose tax returns to audit. It compares all returns against statistical norms, and those outside are flagged. IRS Red Flags for an audit range from simple math mistakes to failure to sign a return. The IRS also uses them to target taxpayers with unusually high incomes and those with foreign assets and cross-border transactions.
Excessive Cash Transactions-IRS Red Flags
Many people don’t like the idea of being audited by the IRS. That’s because they believe it means they are making a mistake or have done something wrong. However, that’s not always the case.
Fewer than one million Americans are audited each year. And of those, a majority are audited because of their actions rather than because of errors they made on their tax returns.
Therefore, knowing the signs that can signal an IRS audit and how to avoid them is essential. For example, excessive cash transactions are a red flag that the IRS may be interested in looking into.
The law requires you to report any cash payments over $10,000. Failure to do so can lead to federal investigations, which can lead to fines or prison time. Financial institutions are also required to report suspicious cash transactions. This is to track down drug dealers, smugglers and terrorists who use large cash transactions to launder money and evade taxes.
Excessive Deductions
The IRS uses a complicated computer program to assess if a tax return should be audited. This process is based on statistical analysis that weighs many different factors.
The most common red flags are excessive deductions, abnormal losses and changes in income. These all have a high correlation with IRS audits.
Expenses like business meals, travel and entertainment are among the most commonly challenged deduction categories. They require proper substantiation, and the IRS always looks for tax returns that fail to meet these requirements.
Unreimbursed employee expenses are also a standard IRS audit red flag. They’re mainly a concern for self-employed people because they often take advantage of these expenses to avoid paying taxes on their total income.
Large Tax Refunds
It’s not uncommon to get a large tax refund each year. They’re often used to pay down debt or splurge on something fun.
But, many taxpayers don’t realize that these checks are not free money from the government; they’re reimbursements for taxes that workers overpaid throughout the year. And as a result, they’re giving the IRS an interest-free loan.
This can put taxpayers in a difficult position, especially when the same level of spending doesn’t match the refund. It may lead to a higher level of spending than usual.
So, if you find yourself splurging more than usual each time you receive a big tax refund, it’s time to rethink your approach. Instead, you could use that windfall to set yourself up for long-term financial success to splurge on the important stuff. Plus, it can help you pay off those credit card bills that have been charging you interest for a while now.
Changes in Income-IRS Red Flags
Changes in income, such as a job loss or a significant windfall gain, can make you more likely to be audited. The IRS can look at the relationship between your return and your W-2 and 1099 forms to see if anything suspicious is missing.
If you own a small business, such as a bar, restaurant, car wash or hair salon, you should be especially careful to document your deductions and donations so that you don’t under-report your taxes.
The new Inflation Reduction Act could give the IRS a much-needed funding boost, which will likely lead to more audits. However, this increase will take time, and the IRS will have to phase in the money, hire new auditors and train them.