Few words make people more nervous during tax season than the word audit. It’s easy to imagine the IRS combing through every detail of your finances, looking for something wrong. In reality, IRS audits aren’t as common as most people think. Most tax returns are processed automatically, and only a small percentage is selected for review.
The good news is that most of the things that increase your IRS audit risk are also the easiest to prevent. Here are some common situations that can draw that extra attention, and how to minimize the risk.
- Make sure all income is reported
One of the most common issues the IRS catches is unreported income. Employers, banks and investment firms all send copies of your tax forms directly to the IRS. If a W-2 or a 1099 exists but doesn’t appear on your return, the IRS system will likely flag it.
This mistake can happen more easily than people think, especially when they have multiple jobs, investment accounts or side income. A good habit is to keep a running checklist of expected tax documents, so nothing gets forgotten before filing.
- Keep deductions reasonable and well-documents
Unusually large deductions relative to a lower income may prompt the IRS to take a closer look at whether everything was reported accurately. The key isn’t to avoid deductions, it’s to make sure they’re legitimate and properly documented.
- Separate business and personal expenses
This is especially important for small business owners and self-employed individuals. Travel, meals, vehicle and home offices expenses are deductible, but they must be clearly connected to the business’ activity. When personal and business spending gets mixed together, it can make deductions harder to support if questions ever arise.
Keeping a separate bank account for business expenses and maintaining clear records can make it easier to minimize problems.
- Document charitable contributions
Charitable contributions are a great way to support the organizations you care about, as well as providing tax benefits. However, large donations relative to income can sometimes stand out on a return. That doesn’t mean they aren’t allowed, but that documentation and receipts are important.
- Recurring business losses
It’s normal for new businesses to have a slow start, and losses can happen. However, if a business reports losses year after year without ever showing a profit, the IRS may question if the activity is more of a hobby. Clear records and an effort to generate profit can demonstrate that the activity is legitimate.
- Double check for simple errors
Sometimes the biggest issues are also the simplest. Incorrect social security numbers, errors or mismatched figures can cause delays or trigger IRS notices. Taking the time to review a return carefully, or having a professional prepare it, can help reduce those kinds of mistakes.
An audit doesn’t automatically mean someone did something wrong. Sometimes returns are selected randomly, or sometimes the IRS just wants clarification in a specific item. But most of the time, minimizing audit risk comes down to a few simple habits: reporting all income, taking legitimate deductions, keeping organized records, and filing an accurate return.
If you ever receive a letter from the IRS, take a breath before assuming the worst. Most notices are routine and can often be resolved quickly once the right information is provided. If that ever happens, our team at Murtha & Flischel is always here to help you navigate the next steps.