Audits versus no audits. That’s always the question. While nothing is ever a guarantee, most practitioners know that certain line items, or forms are at higher risk of audit than others. But what actually increases the odds of your clients experiencing an audit? Below are 5 red flags that statistically increase the likelihood of an IRS second look.
1. Higher income
The magic number is still about $400,000. In spite of rumors that new agents were being hired to audit more households below this threshold, the IRS has maintained that is not the case. AGI more than $400,000, however is traditionally more likely to receive a second look.
2. Overdoing the deductions
Most returns are now electronically filed, making it easier than ever to run statistical analysis on numbers and pull out anomalies. That means that taxpayers taking higher than average deductions and/or credits may be more susceptible to an audit. The higher numbers do not necessarily mean you did anything wrong, but in a year where maybe you made a higher-than-normal charitable contribution, be prepared to back it up.
3. Schedule C
Sole proprietors and SMLLCs grossing more than $100,000 are more likely to flag an audit. Furthering this risk is businesses that traditionally operate more in cash, have large vehicle expenses (like claiming 100% business use of auto) or businesses that claim large losses.
4. Rental losses
Rental losses can only be offset against rental income. Be careful any time your clients are claiming rental losses to make sure they’re properly offset. Exceptions do apply but they’re subject to income limits, or in some cases when the owner is working full time as a property developer or manager. If your client has another W-2 from a full-time job, but still is claiming that they work full-time on the property, make sure they can back up those hours.
5. Engaging in digital currency transactions
Despite the rise in popularity, cryptocurrency is still a no fly zone for the IRS. The lack of regulations and reporting requirements make this one an easy red flag. It’s difficult to always determine if taxpayers reported 100% of their income from crypto, making it a hot target for an audit.
The key in any situation is to remind clients that they need to have irrefutable documentation to support the numbers on their returns. Make sure you’re well versed in what your clients have on their returns as well to avoid any unintended mistakes.