How to avoid an audit by the IRS: These red flags may invite an IRS examination
President Donald Trump famously declared that his tax returns have been audited every year for many years. "Twelve years or something like that," he said last fall during a debate.
Is a tax audit something for the average taxpayer to be worried about?
Audits have declined in recent years, owing to a loss of 30 percent of the IRS' enforcement staff since 2010. In fiscal year 2016, the agency says it audited nearly 1.2 million tax returns, or just 0.6 percent of the total.
Seven out of 10 audits were conducted after a notice like this:
Some of the information that you provided to us does not agree with the information we received from other sources.
— The Internal Revenue Service
Focus on richer taxpayers
In recent years, the tax collector has been focusing on the wealthy. If you earn $10 million or more, you have a roughly 1 in 5 chance of getting audited. But for most taxpayers, the odds are less than 1 in 100.
Here's the breakdown:
Percentage of individual returns audited in 2016
|Size of adjusted gross income||Returns audited|
|No adjusted gross income||3.25%|
|$25,000 - $49,999||0.49%|
|$50,000 - $74,999||0.41%|
|$75,000 - $99,999||0.52%|
|$100,000 - $199,999||0.62%|
|$200,000 - $499,999||1.01%|
|$500,000 - $999,999||2.06%|
|$1,000,000 - $4,999,999||4.6%|
|$5,000,000 - $9,999,999||10.46%|
|$10,000,000 or more||18.79%|
Source: Internal Revenue Service Data Book, 2016
What tax bracket are you in? Do this quick calculation to find out.
What's the DIF?
In addition to a filer's overall income, other figures can attract auditors' attention.
A return can be selected for audit via the IRS' computer-scoring system known as Discriminant Information Function, or DIF. The DIF looks at deductions, credits and exemptions, with norms for taxpayers in each of the income brackets.
The actual scoring formula to determine which tax returns are most likely to be in error is a closely guarded secret. But it's no mystery the system is designed to screen for returns that could put more money in the U.S. Treasury.
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How do your deductions compare?
Tax experts believe one discriminant information function component looks at average deduction amounts. This allows IRS examiners to spot inconsistencies, such as a high mortgage interest deduction for someone with low income.
Tax specialists at Wolters Kluwer Tax & Accounting US examined 2014 return statistics, the latest complete data, and came up with the following itemized deduction averages. The experts note that the IRS takes a dim view of taxpayers who base their claimed deductions on these figures. The numbers can be useful, however, in giving you a general idea as to whether certain deductions on your return might seem out of line.
Average deduction amounts according to income
|Income range||Medical expenses||Taxes*||Mortgage interest||Charitable contributions|
|$15,000 - $30,000||$8,477||$3,376||$6,619||$2,339|
|$30,000 - $50,000||$8,209||$4,098||$6,511||$2,594|
|$50,000 - $100,000||$9,614||$6,679||$7,553||$3,147|
|$100,00 - $200,000||$11,122||$10,983||$9,147||$4,130|
|$200,000 - $250,000||$18,092||$17,763||$11,642||$5,786|
|$250,000 or more||$36,992||$50,679||$16,982||$21,596|
*State and local income and sales taxes
Source: Wolters Kluwer, 2017
So, besides a higher income or deduction disparities, what else might trigger a red flag?
- Income other than basic wages; for example, contract payments.
- Unreported income, such as investment returns.
- Home-based businesses, especially when in addition to salary income, and home office deductions.
- Noncash charitable deductions.
- Large business meal and entertainment deductions.
- Excessive business auto usage.
- Losses from an activity that could be viewed as a hobby rather than a business.
- Large casualty losses.
Returns claiming the earned income tax credit, or EITC, designed as a tax break for lower-income wage earners, also get IRS attention. The credit's complexity often results in legitimate mistakes on returns. Some filers, however, have been caught making false claims to increase the payment the credit provides.
Are you entitled to claim the earned income tax credit? Check out Bankrate's EITC calculator.
Schedule C filers who report a business loss also are likely to face more questions from the IRS.
But don't be afraid to claim all the deductions and credits to which you're entitled. Even if your return is questioned, it's not a foregone conclusion that you'll end up owing the IRS. As long as your deductions and expenses are legitimate and you have documentation, they will be allowed.