Tax Audits: Are You Flying Below the Radar?

Accurate, timely tax returns that are free of certain red flags can prevent IRS tax audits. The IRS has a computer system that scans every tax return checking for mathematical errors, duplicate information, tax deductions, and other red flags that may signal a tax audit.

Avoiding a Tax Audit

Although only seven percent of taxpayers get audited, taxpayers can take certain precautions to reduce their risk.

Reporting Income

The IRS keeps track of taxpayer income through various types of payment documents from employers and banks including W-2s, 1099-Misc, 1099-Int, and 1099-Div forms. When a taxpayer receives any of these forms, the IRS gets a copy. If a taxpayer files a tax return that doesn’t include the payment information on such forms or includes a lesser amount than what was reported, the IRS is alerted and the risk of a tax audit becomes greater. Even if omitting the information was a legitimate mistake, the IRS may think that the taxpayer is trying to hide income.

Tax Deductions

Large or excessive tax deductions can increase the risk of a tax audit. The IRS looks at tax deductions in relation to reported income. For taxpayers who earn between $50,000 and $100,000 a year, for example, a return that shows $30,000 of charitable deductions will signal a red flag alert.

Large Cash Purchases and Deposits

Certain types of businesses must report large cash transactions, usually $10,000 or more, to the IRS. This includes large cash purchases for houses, vehicles, jewelry, and furnishings, as well as large cash deposits in bank accounts. When reviewing tax returns, the IRS looks for sufficient income that supports the legitimacy of large cash purchases and deposits.

Cash Businesses

Taxpayers who work in cash businesses are at higher risk of tax audits. People employed in restaurants and bars, hair and nail salons, ride-share services, and other cash businesses must be careful to report all income, including cash. If reported income does match a taxpayer’s lifestyle, debts, and deductions, the IRS may suspect that all income has not been reported.