Audit letters are bad enough, but the fear and stress of interacting with the IRS often comes with a second, less certain feeling: what did I do wrong? Audits look for specific actions and patterns, and understanding their targets can help you know what your next steps are and make breathing a lot easier. Here’s what the IRS wants to find:
Underreported Income
You must account for all your income when you file for taxes. This includes:
- Salary and wages from W-2s
- Income from freelancing
- Rental income from investment properties
- Income from gambling or other sources
Not outlining your sources of income on your return is a fast way to be a target in an audit. Discrepancies between reported income on tax returns and information reported by third parties can prompt an audit.
Excessive Deductions
Claiming unusually high deductions that are not typical for your income level can raise red flags. This can include:
- Misclassification of expenses: Incorrectly categorizing personal expenses as business expenses can lead to scrutiny.
- High Charitable Contributions: Claiming large charitable donations relative to your income can attract attention.
- Home Office Deductions: Incorrectly claiming a home office deduction without meeting the specific requirements can be risky.
- Business Losses: Reporting business losses year after year without showing a path to profitability may lead to questions about whether it’s a hobby or a business.
The deductions you take are closely scrutinized by the IRS. Accuracy here is vital.
Cash or complex investment transaction
Businesses that deal heavily in cash, such as restaurants or bars, are often scrutinized more closely. On the other hand, involvement in complex financial transactions or owning multiple investment properties can increase audit risk due to the complexity of correctly reporting them.
Being audited does not mean you’ve done anything wrong
An audit is not a criminal charge; it is simply a check on your filings. If there’s an honest mistake in your taxes, the IRS is often happy to work with you to fix things and make things even. And, more often than not, the IRS can simply be wrong. But when you face an audit, you don’t have to face it alone.