What Triggers An IRS Audit?

Well, first of all, what is exactly an IRS audit? And why do the IRS audit people? An IRS audit is an examination of your information to make sure you’re reporting correctly and following the US tax laws. Basically, the Internal Revenue Service wants to check if there are any discrepancies between what the IRS is owed and what the IRS actually receives your 1099 income is tied to your Social Security number. If you don’t report all of the income the IRS already knows that you have earned the income and this could show up as a clear discrepancy. Then you will receive an IRS audit notice.

What Red Flags Are Likely To Trigger An Audit?  

Sometimes an IRS audit is random but the IRS sometimes chooses taxpayers based on their odd and suspicious transactions and activities. According to the IRS, about 0.15% of individual returns got audited and examined in the 2019 year. It’s not terribly a lot but you can’t avoid an IRS audit or getting an IRS Form 566.

Let's go over all the tax preparation audit triggers that the IRS uses to see if you are misreporting your taxes.

High Earner

The more money you make, the higher chance you hear from the IRS. According to the IRS, people who make more than $1 million are more likely to get audited. If you make less than a million annually, the possibility of auditing gets cut in half.  

You’re Self-employed

The returns of self-employed or sole proprietorship filers are being audited at higher rates than non-business owners. This is mainly because people could claim too many expenses or claim personal expenses as a business expense. This sometimes leads too many losses on a schedule C. The IRS may wonder how your business is staying afloat. When you claim expenses, you should justify a true business purpose for these 1099 tax write-offs. Make sure that your expenses make sense in comparison to your business income. Keep your receipts and statements along with your journals where you indicate a short description of business purpose.

That is why it is vital to have proper documentation of all your business expenses.

Not Reporting All Of Your Income

Underreported income is the most dangerous thing ever. The IRS typically receive a copy of all the tax forms that you do, including forms 1099-MISC, 1099-NEC and W-2. The more income sources you have, the greater chances you may overlook to report that income. The best way to include all your income sources is to download a copy of the wage and income transcript from your IRS account. You may discover one or two hidden income sources that surprise you when filing taxes.

Math Errors

Double-check your numbers before you file your taxes. Ironically, math errors can trigger an IRS audit even if the mistake is in the favor of the IRS. According to the IRS, errors sometimes look shaky and fishy and that may bring on additional scrutiny from the IRS. Mistakes happen but be careful and make sure all numbers are correctly flown through when you file returns.

Claiming a Home Office Deduction

Many small business owners and freelancers are afraid to take this deduction because they’ve heard it will trigger an IRS home office deduction audit. But if you deserve it, why not take advantage? The IRS says “if you use part of your home for business, you may be able to deduct expenses for the business use of your home.” Specifically, if you use part of your home regularly and exclusively for conducting business, you can take a home office deduction. You must then show that you use your home as your principal place of business.

Using Neat & Round numbers

If the numbers on your tax returns are too simple and clean such as $1,000, chances are you get audited. Don’t round to the nearest hundred or thousand, rather round to dollar. If your number happened to be unrealistic, for example, the numbers end in a double zero, keep good records and be specific when writing off expenses.  

Use Your Personal For 100% Business Purposes

Business-related auto expenses can be claimed on tax returns especially when taxpayers are self-employed or freelancers. As this auto expense is another great possible tax deduction for all self-employed taxpayers, the IRS tends to look carefully. Again, as long as you keep proper records such as mileage logs and car-related receipts, taking this deduction is a must!

A Drastic Change In Income Or Expenses

If the numbers in your tax returns fluctuate dramatically from year to year, the IRS would wonder why. It happens and you can of course make and lose as much as you can but be prepared, keep all records and document related statements and papers.  

You can be audited for large cash deposits in your bank account.

Cash-Heavy Business  

Cash business is more likely to be audited. In general, Convenience stores, restaurants, laundromats, car washes, and beauty salons are considered cash business. They tend to be more audited as they deal with cash and its harder to track cash income than credit card/debit card/check income. Many small business owners that deal with cash didn’t report those cash income in the past, so now the IRS targets them more aggressively. In short, even without a 1099 you have to report your cash income.

You Have Three Consecutive Years Of Business Losses

Have you heard anything about a hobby loss? If losses are reported for three consecutive years on your income taxes, those losses may not be considered a business loss by the IRS. The IRS sees that as a hobby loss that can’t be claimed at all. Basically, if you haven’t shown a net profit from it in at least three of the last five tax years. If you could prove that your business activity was for for-profit, you may be able to avoid this hobby-loss limitation and to be considered a business. Otherwise your deductible expenses would not be allowed as a tax write-off from your taxable income.

What To Do If You Are Audited

Listen, if you get a tax audit, it’s not the end of the world. You only need to respond to the IRS in a polite, cooperative, and timely manner. You may want to consult with a tax professional, CPA or tax preparer if you’re audited, especially if there’s a large sum of money involved.

In general, most audits happen two to three years after a return is filed. The IRS has a three-year statute of limitations for tax returns, although sometimes, that can be extended to six-year.  You should hold onto your records for at least 6 years so you can prove the claims you made for your self-employment taxes.

The Bottom Line

You shouldn’t be afraid of an IRS audit as long as your tax filing is accurate and you keep proper documentation of your records. In other words, being honest is the best weapon. If you have clean record keeping for everything you put on the return, you’re good to go.

Soo Lee

Soo Lee

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Soo has over 10 years of experience in publicly traded companies and public accounting firms offering tax, accounting, payroll and advisory services to clients in diversified industries including manufacturing, wholesale/retail businesses, construction, real estate development and investment, banking, finance and professional/legal consulting service. In Particular, when Soo was at Pricewaterhouse Cooper, Soo worked with many foreign owned U.S. companies and advised clients on a broad range of issues including federal and state tax minimization especially through R&D tax credit, determination of the optimal structure for new foreign investments, restructuring and reorganization for existing operations.

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Note: at Keeper Tax, we're on a mission to help freelancers overcome the complexity of their taxes. That sometimes leads us to generalize tax advice. Please reach out via email if you have questions.

Discover the tax write-offs you've been missing

Keeper Tax automatically finds tax deductions among your purchases. On average, people discover write-offs worth $1,249 in 90 seconds.

Download Keeper Tax→

Discover the tax write-offs you've been missing

Keeper Tax automatically finds tax deductions among your purchases. On average, people discover write-offs worth $1,249 in 90 seconds.

Download Keeper Tax→
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