What are My Chances of Being Targeted for an IRS Audit?

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According to the recent Kiplinger Tax Analysis, the Internal Revenue Service (IRS) is struggling with its enforcement efforts as the agency’s funding has been significantly reduced over the past several years. Some interesting statistics included:

  • 2012 audit rate for individuals was the 0.96% – approximately 1 out of 100 filed returns (lowest since 2005)
  • 2013 audit rate for individuals is projected to be at 0.80%

The odds may seem very low for the return to be picked for a review; however, taxpayers should look at the following factors (selected by Kiplinger’s Personal Finance Magazine) that could increase further scrutiny by the IRS and potentially result in a full-blown examination of your income tax return:

  1. Large Gross Income – According to the IRS statistics, even though the overall individual rate is below 1%:

i.            Taxpayers with incomes of $200,000 or higher had an average audit rate of 3.26%

ii.            Taxpayers with incomes of $1mil or higher had an average audit rate of 11.11%

  1. Failure to properly report all taxable income – The IRS receives copies of all forms 1099s and W-2s; a mismatch is easily detected by the IRS computers and a subsequent notice will be issued.
  2. Large Charitable deductions – The IRS is aware of the average charitable donation for taxpayers in various income categories (ex., taxpayers with Adjusted Gross Income in $100k-$200k range reported, on average, $3,939 charitable deduction). If your deduction is disproportionately larger, it raises a red flag. Also note that, for noncash donations in excess of $500, a form 8283 must be included with your tax return and, for noncash donations in excess of $5,000, an appraisal is required.
  3. Schedule C – Considered by some as a goldmine for IRS agents, as history shows that most understating of income and overstating of deductions is done by those who are self-employed.

i.            Hobby Losses – don’t confuse a hobby with a business. The activity must be conducted with the intent of making a profit; the law presumes you have a business if the activity at a minimum generates profit three out of five years. Also make sure that you have proper documentation for all of the expenses. If, however, you determine that the activity is actually a hobby, report any income and deduct any expenses only up to the level of income; the law prohibits writing off losses from a hobby.

ii.            Home Office – you must use the space exclusively and regularly as your principal place of business (this area of the home should not be used as a family room in the evenings or a guest bedroom).

iii.            Business Use of a Vehicle – claiming 100% business use of a vehicle is another red flag for the IRS and will get challenged; make sure you keep detailed mileage logs so that the deduction will not get disallowed.

iv.            Meals, Travel, and Entertainment – to qualify for the deduction, you must keep detailed records for each expense amount including: the place, people attending, business purpose and the nature of the discussion/meeting. Taking excessive deduction will draw additional attention from the IRS, so make sure you have proper documentation.

v.            Day-Trading Losses – many taxpayers who trade in stocks and other securities take an aggressive position of a “trader” rather than investor and report trading losses and expenses on Schedule C. The IRS is selecting those returns to determine if the taxpayers actually qualify as bona fide traders.

  1. Rental Losses – The IRS launched a “real estate professional“ audit project several years ago that targets taxpayers with real estate losses who claim to be real estate professionals. As a general rule, in order to qualify as a real estate professional, you must spend more than 50% of the working hours and 750 or more hours each year materially participating in a capacity of a real estate developer, broker, landlord, etc. If however, you hold a full-time job (outside of real estate) most likely you will not qualify as a real estate professional and the losses from your rental activity will be either limited to current year income or suspended to future years.

Claiming a higher than average deduction or loss on your income tax return may draw an unnecessary attention from the IRS; however, if you have proper documentation, you have nothing to worry about.

For more information about potential audit red flags, please contact your Aronson tax advisor or Anatoli Pilchtchikov at 301.231.6200.

About Anatoli Pilchtchikov

Anatoli Pilchtchikov has written 14 post in this blog.

Anatoli Pilchtchikov is a senior manager in Aronson’s Personal Financial Services Group, where he specializes in tax compliance and consulting for high net worth individuals and their families, corporate executives and business owners. Working closely with clients and their investment and legal advisors, Anatoli plans and implements strategies designed to effectively achieve financial and estate planning objectives. As a trusted member of a client’s advisory team, he helps integrate financial plans with sound tax guidance in the areas of retirement and estate planning, risk management and investment planning.

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One thought on “What are My Chances of Being Targeted for an IRS Audit?

  1. […] The odds may seem very low for the return to be picked for a review; however, taxpayers should look at the following factors (selected by Kiplinger’s Personal Finance Magazine) that could increase further scrutiny by the IRS …read more […]

    September 25, 2014 at 8:27 am

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