Nobody wants an audit notice from the IRS. While audits are not entirely avoidable, understanding their triggers can significantly reduce your risk. In this week’s episode of Business by the Numbers, Hunt Demarest, CPA, breaks down the most common reasons businesses and individuals find themselves under the IRS’s microscope.
What Triggers an Audit?
- Underreporting Income Forgetting to include income from all sources is a common mistake that can lead to an audit. For instance, taxpayers often overlook income from brokerage accounts, dividends, or even retirement accounts from previous employers. Even minor discrepancies, such as underreporting $100, can raise a red flag with the IRS. Make sure to account for every source of income to avoid unwanted attention.
- Gambling Income Both gambling winnings and losses are closely monitored by the IRS. Winnings are required to be reported as income, while losses can only be deducted up to the amount of your winnings. Documentation is key. Keep detailed records of wins and losses, as this is a frequent area for audits due to misreporting or lack of evidence.
- High-Risk Professions and Hobbies Industries such as art, wine, and horse breeding often face extra scrutiny because they’re seen as high-risk for misreporting. These fields often involve large sums of money and are perceived as difficult to track due to a lack of digital record-keeping. If you’re involved in these industries, maintaining meticulous records is critical to avoiding audits.
- Amended Returns Making changes to previously filed returns, especially those involving Schedule C income, is almost guaranteed to attract the IRS’s attention. The agency views amendments as a potential sign of inaccuracies in the original filing. It’s best to avoid amendments unless absolutely necessary and ensure any changes are well-documented and justifiable.
- Excessive Losses Reporting significant losses, especially if they offset substantial income, is another major red flag. For example, claiming losses in real estate or a small business to reduce taxable income can attract audits. The IRS is particularly suspicious of large losses that wipe out taxable gains.
Tips to Stay Off the Radar
- Document Everything: Keep thorough records of all income, expenses, and deductions. Incomplete or inaccurate documentation can lead to audits.
- Work with Professionals: A knowledgeable CPA can help ensure your tax return is accurate, complete, and less likely to attract scrutiny.
- Avoid Filing Late: Filing on time demonstrates professionalism and reduces suspicion. Late filings can increase your audit risk.
- Use IRS Online Tools: Set up an account on the IRS website to verify income and access any reported earnings before filing your return.
- Understand High-Risk Areas: Be aware of the tax implications of your industry or activities, especially if you’re involved in hobbies or professions that commonly attract audits.
Final Thoughts
Avoiding an IRS audit is about being proactive. Understanding the triggers and ensuring compliance with tax laws can help safeguard your financial health. If you’re unsure about your tax situation, consult with a trusted CPA who can guide you through the process and help you avoid costly mistakes.
For more insights, tune in to the full episode of Business by the Numbers and stay informed on how to protect yourself from IRS scrutiny.
