money 5 red flags that can trigger a tax audit from the IRS
Of the millions of taxpayers who filed their 2020 taxes, a handful of unlucky ones may have their returns singled out by the Internal Revenue Service for an audit.
It's not terribly likely. In the 2019 fiscal year, only 0.45% of the individual tax returns were audited, according to agency data, a rate that has significantly dropped in the last decade due to staff and budget cuts. But certain red flags may make you more likely to fall into that unfortunate group, experts said.
"Less than 1% of people are actually audited," Lisa Greene Lewis, a tax expert with TurboTax, told Yahoo Money. "A lot of times people may receive something from the IRS and they think [that] just because it's a letter, it's an audit. But sometimes, there are adjustment letters."
The IRS sends an adjustment letter when you made a miscalculation or underreported small amounts of your income, but this is not an audit. A correspondence audit — the lowest form of an audit and not a full examination — is performed via mail and may require you to provide additional information. But a correspondence audit can turn into an in-person audit if the issues become more complex.
The best way to prevent an audit is to avoid tax scenarios that catches the IRS's attention in the first place. Here are five ways to do that.
Underreporting income
One audit trigger is if you exclude some income sources or report a smaller amount of income than you actually received.
"Underreporting income would probably be the first red flag," Greene Lewis said. "These are cases where you're grossly underreporting. This is like underreporting your income by $5,000 intentionally."
Forgetting a form or unintentionally leaving out a small portion of your income may not get you audited. But if there's a bigger discrepancy between the income you actually earned and what you reported on your return — and if it's intentional — chances are higher that you may get audited.
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Companies that pay your income — from employers to those distributing investment income — also report that income to the IRS. That means a mismatch between what the IRS has for your income versus what you report on your return can be detected by the agency.
The IRS usually can go back and review your returns for the last three years if there's a discrepancy. If you've left out income intentionally, the agency can review your return for the last six years. In cases of fraud, the IRS can go back as far back they want in your return history, according to Greene Lewis.
Overstating your tax deductions
Whether you're claiming business tax deductions like meal and entertainment expenses or personal ones like charitable donations, you may hear from the IRS if the claimed amount seems off based on your income, Greene Lewis said.
The IRS system that roots out suspicious tax returns may flag a return that has deductions that are too high for the reported income level compared with other similar returns.
Mixing business and personal expenses can also be a red flag for the IRS. Some small business tax deductions that could pose a problem if disproportionate to your income are expenses for vehicles, home office, meals, and entertainment, among others.
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Charitable contributions are also scrutinized by the IRS. The agency knows the average donation per income bracket and big discrepancies can trip up a return. Another issue that will catch the IRS's attention: Not filing Form 8253 for non-cash charitable donations over $500.
High-income earner
The chances of being audited increase with your income bracket.
While the overall audit rate for 2018 was 0.6%, the chances of being audited was much higher for high-income earners. Taxpayers reporting income from $500,000 to $1,000,000 were almost twice as likely to be audited at 1.1%. That rate went up to 2.2% for taxpayers making from $1,000,000 to $5,000,000. Those earning $5,000,000 to $10,000,000 saw an audit rate of 4.2%, while those making above that threshold saw the highest rate of 6.7%.
Taxpayers with higher incomes often have more complex tax returns that likely include one or more audit red flags.
Claiming a dependent
Only one parent is allowed to claim a child on their taxes, even if the parents are filing their taxes separately.
"Maybe there's a couple that has a child, and they may not be together and not discussing who's going to claim the child." Greene Lewis said. "If they both try to claim the child, people see dependency questions."
In this case, the IRS may send an audit letter to determine which taxpayer is entitled to claim the child as a dependent. A child can be claimed as a dependent if the child is under the age of 19 or is a full-time student under the age of 24 and lives with you for more than six months of the calendar year.
Foreign accounts and income
Failing to report a foreign financial asset like a bank account, brokerage, or mutual fund may also bring the IRS knocking.
If you hold foreign assets worth over $50,000 for a single filer and $100,000 for joint filers, you must fill out Form 8938, identifying the institution where the assets are held and the highest value of those assets in the last year.
Additionally, if you take the Foreign Earned Income Exclusion break, the IRS may carefully review your return for any discrepancies. U.S. citizens who are bona fide residents of a foreign country can exclude up to $107,600 of their 2020 income if they were in that country for at least 330 full days during any period of 12 consecutive months.
"When you're doing your tax return, you let them know if you have any foreign income," Greene Lewis said."If you didn't claim that income, then it could be a red flag if they figure out that you do have foreign income."
Denitsa is a writer for Yahoo Finance and Cashay, a new personal finance website. Follow her on Twitter @denitsa_tsekova
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