For most taxpayers, it's unlikely that they will be audited by the IRS. But that doesn't mean it's completely out of the question. While the number of audits dropped to its lowest point in 14 years last year, the IRS knows that every $1 spent on audits brings in $4 to the Treasury Department. We spoke to several tax experts and found out just what the IRS is looking for when it's considering an audit and how you can trigger an audit through mistakes, oversights, and not-so-brilliant deductions.
The IRS is certainly going to want a word with you if you don't file a return -- the bare minimum you have to do at tax season. If you owe the IRS and don't pay, you'll be slapped with both late payment and late filing penalties that add up quickly. Even if you owe nothing or have no income, file anyway, says Mark J. Kohler, senior adviser at online tax firm TaxSlayer.
"The IRS is like a boyfriend or girlfriend, if you don't stay in touch, they will assume the worst," Kohler says. "They'll also say bad things about you to their friends."
"Correlation or causation is another debate, but the more money you make, the higher the risk of being audited," Northwestern Mutual's Bonneau says. "If you're making $10 million a year, there's a higher likelihood that you're going to be audited than someone who claims $35,000."
Granted, those wealthier folks tend to be business owners making more deductions that are worth more money, but the IRS knows where the big money is. Back in 2016, the chance of the IRS auditing a person or married couple making less than $500,000 was less than 1 percent. For those making more than $10 million, it was 19 percent.
TaxSlayer's Kohler notes that the easiest way to produce an accurate tax return that keeps the IRS happy is to keep the best accounting records you can. The more detail you can provide, the less the IRS has to ask for.
"Receipts have nothing to do with keeping you out of an audit, but they can certainly reduce the severity of an audit and even reduce the extent and time it may take," Kohler says.
When you file a tax return, you also indicate the industry you work in. This allows the IRS to categorize your expenses and look for abnormal expense levels compared to your income.
"Obviously, you would never increase an expense because it wouldn't be noticed, but you certainly should consider reducing an expense if it is far too high and will stand out," TaxSlayer's Kohler says.
The 1099 form is a blaring alarm for the IRS. Kohler notes that employers should request W-9 forms for all subcontractors before they get paid and issue 1099 forms in January, following proper procedures. You may get away with a late 1099 form here or there, but making a habit of not sending those forms out will practically invite the IRS to your doorstep. "If you already missed the deadline this year, don't let it happen again," Kohler says.
So you've retired and opened your own junk shop or barber shop/salon. You make just about enough to pay the rent, but occasionally pay out of pocket to keep things going. If you're not making a profit, but aren't considered a not-for-profit business, congratulations: The IRS now considers you a hobbyist and may audit you to make sure you aren't taking advantage of business deductions.
"The IRS does not like illogical behavior," says Northwestern Mutual's Bonneau. "If you have a business that shows a huge loss or a loss year after year, they are going to wonder how you are in business."
For freelancers, tax time can be a messy tangle of different employers and 1099 forms, and a missed 1099 form for even a minor amount can catch the IRS' attention once it cross references with an employer's deduction. Bonneau says tracking your employers and their paperwork is of utmost importance in the gig economy.
"There are so many people now who are self-employed or freelancers and are filing a self-employed tax return, which in and of itself makes you more likely for audit than if you're just a traditional W-2 employee," she says.
It doesn't matter if you're trying to deduct mileage, supplies, charitable donations, or your mortgage interest: Close doesn't count. Keep your receipts and billing statements, calculate the numbers down to the last cent and submit that. Just because the threshold for a deduction is a round number doesn't mean you can just round right up to it.
"How many people actually spend $400 on office supplies in a given year?" Kohler says. "I don't think you could go through Staples and create one or two purchases that exactly add up to $400 even if you tried."
You are entitled to a home-office deduction if you work from home and can calculate the square footage, utilities and other expenses of your office space. While you can try to determine which portion of a home's expenses, taxes, insurance and depreciation is dedicated to a home office, a simplified version multiplies the square feet of the room by $5 (if the total size is 300 square feet or smaller). Just watch out if the expenses inflate beyond that multiple of $5.
"Have a procedure/calculation and remember 'pigs get fat and hogs get slaughtered,' " says TaxSlayer's Kohler. "Don't get greedy."
Those expenses should look normal, well-balanced, and conform to your income level and industry. If you are a sales representative on the road hawking products, those type of expenses will appear standard. However, if you run an Etsy page out of your basement in the evenings, daily dining and golfing expenses aren't typically part of the deal.
"Bottom line, don't be afraid to take an expense that you're entitled to, especially if you kept good records," TaxSlayer's Kohler says. "But also make sure you're filing your reports and tax return doesn't stand out. This isn't the prom. You want to stand in the corner and not get asked to dance."