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4 red flags for an IRS tax audit — including what one tax pro calls a ‘dead giveaway’

Smart Tax Planning
  • While the chances of an IRS audit have been slim, the agency may scrutinize your return for several reasons.
  • Some red flags for an audit are round numbers, missing income, excessive deductions or credits, unreported income and refundable tax credits.
  • The best defense is proper documentation and receipts, tax experts say.
Jeffrey Coolidge | Photodisc | Getty Images

This tax season, there have been heightened concerns about IRS audits as the agency begins to deploy its nearly $80 billion in funding.

While the IRS plans to hire more workers, including enforcement agents, experts say there’s no need to worry — as long as you keep proper documentation.

Still, certain red flags are more likely to trigger an IRS audit, experts say. “Round numbers are a dead giveaway,” said Preeti Shah, a certified financial planner at Enlight Financial in Hamilton, New Jersey. She is also a certified public accountant.

Here’s why round numbers catch the agency’s attention, and three more closely watched factors.

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1. Round numbers

When claiming tax breaks, it’s important to use accurate numbers rather than estimates on your return, experts say. Round numbers indicate you’re estimating.

For example, if you’re a sole proprietor with $5,000 for advertising, $3,000 for legal expenses and $2,000 for support, “the IRS knows you’re just winging it,” Shah said.

2. Missing income 

A key issue that may trigger an IRS audit is missing income, according to John Apisa, a CPA and partner at PKF O’Connor Davies LLP.

Your tax return must match the income reported by companies and financial institutions or you may get an automated notice from the IRS. For example, it may be easy to skip Form 1099-NEC for contract work or Form 1099-B for investment earnings, he said. 

You should wait to file until you have all your documentation in hand and check to make sure what you entered matches what’s on the forms. “You have to be careful, even with the simpler stuff,” Apisa said. 

3. Excessive tax breaks compared to income

Another possible tipoff is attempting to claim credits or deductions that seem too high when compared to your income, Apisa said. 

When your tax breaks don’t align with what’s expected for your income level, “there’s usually a flag there,” he said. For example, if you have $90,000 of earnings with $60,000 in charitable deductions, that may set off an alarm in the IRS system, he said.

4. Earned income tax credit

The IRS has also examined refundable credits, which can provide a refund even when the credit value exceeds taxes owed.

While audits have declined overall, the drop has been lower for filers claiming the earned income tax credit, or EITC, targeted at low- to middle-income workers. “That’s usually one of the ones that gets scrutinized more,” Apisa said.

Between fiscal years 2015 and 2019, audits dropped by 75% for taxpayers making $1 million or more, and 33% for filers claiming the EITC, according to a 2021 report from the Treasury Inspector General for Tax Administration. 

More focus on the EITC has also contributed to higher audit rates among Black Americans, a recent study found.

How to protect yourself from a future IRS audit

Ilkercelik | E+ | Getty Images

“People are scared to death of the IRS,” said Karla Dennis, an enrolled agent and founder of Karla Dennis and Associates. “They don’t understand how the system works, and so they’re extremely fearful of audits.”

But the best way to protect yourself is by staying organized, with receipts and records to show proof of income, credits and deductions, she said.

Depending on your situation, it may be necessary to keep tax records for up to seven years, according to the IRS.

But if you’re missing a receipt, copious records may provide the narrative needed to back up your position in an audit, Dennis said.

“Document, document, document,” she added. 

Source: Investing - personal finance - cnbc.com

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