Wouldn't it be nice if the IRS released its secret formula for how it selects individual tax returns for audit? That way, we'd do everything we could to stay under the radar and not be selected for further review.
Fewer than 1 percent of tax returns are audited, which is good news for all. But there's no way to guarantee you'll be exempt from the IRS' prying eyes, so all you can do is take the proper precautions and hope for the best.
CPA Stacy Johnson discusses three red flags that may trigger an audit and how to avoid them. Take a look and keep reading below for additional tips.
1. Shady preparers
If you don't prepare your own return or take advantage of the free help that is available if you make $52,000 or less, chances are you will entrust someone else with your information to prepare your return. Just make sure the individual is legitimate, or you may end up in the IRS' hot seat.
How do you spot a shady preparer? If they make ridiculous claims, like guaranteeing that all of their clients will get refunds, you definitely want to seek other options.
2. Business or hobby?
Have you been in business for at least three years and your tax return still reflects a loss? Chances are the IRS may view your business activity as a hobby, which is another red flag.
And if you used a Schedule C to claim your losses instead of incorporating, that also increases your chances of being placed under a microscope by the IRS.
So, what are you to do if your business is really losing money because it's a startup or as a result of economic conditions? Take the deductions you are entitled to, but maintain adequate documentation to substantiate your claims.
3. Too much generosity
Perhaps 2013 was the year of giving, and you doled out large sums of cash that were disproportionate to your income? Your actions may raise a few eyebrows at Uncle Sam's headquarters.
According to IRS Publication 526, charitable deductions are limited to 50 percent of your adjusted gross income, with 20 and 30 percent limitations applied in some cases. And if your individual contributions are $250 or more, you must keep a bank record showing the donation or a document that includes your name, the date the gift was given and the amount.
4. Cash earners beware
If you are employed in a position that works for tips, such as a bartender or restaurant server, it is important to understand that all tips received must be reported as income; it is against the law to do otherwise.
While it may be possible to understate income, the IRS has a certain threshold that it expects servers to meet, and any amount substantially less may raise a high level of concern, and possibly trigger an audit