By Steven Brettholtz, CPA, CFF
If you are a gambler, it's a pretty safe bet that you won't get audited by the IRS, at least statistically speaking. Less than 1 percent of tax returns are audited. However, that percentage jumps to 5.8 percent for individuals earning more than $1 million. And there are several IRS inquiries, like a notice of income discrepancy or proposed additional tax due, that are far more likely to occur than a full-blown audit. The following are some common reasons that your tax return can spark additional interest from the IRS.
If your reported income does not match what the agency has on file as reported by your employer, banks, investments, and the like, you can expect to get a letter from the IRS. The agency gets copies of all the same 1099s and W-2s sent to taxpayers. Failing to report income is one of the most consistent reasons the IRS will question a return.
Unusually Large Charitable Donations
The IRS maintains data about how much taxpayers at various income levels typically donate. Contributions that are significantly higher can trigger an additional review. However, 2018 might prompt the IRS to reconsider this strategy. To take a deduction on charitable contribution you must itemize your deductions. With the changes that went into effect for the 2018 tax year, which doubled the standard deduction, some taxpayers will now choose to “bunch’ their charitable contributions. This means they contribute a larger amount in one year in order to itemize and deduct the donation, but will not donate the next year and take a standard deduction. This will make their donation significantly higher some tax years.
Dipping into Retirement Funds Too Early
There’s nothing about making early withdrawals from an IRA or 401(k) that’s contrary to tax law. However, the IRS reports that 40 percent of taxpayers taking early withdrawals make mistakes when they report doing so on their returns. This makes their returns a likely candidate for additional review. Most mistakes relate to taxpayers not paying the tax penalty for early withdrawals. If you are younger than 59 ½ when making the withdrawal there is a 10 percent tax penalty. There are exceptions to the penalty, but you can be sure the IRS will want proof you qualify if you claim one.
Attention all you Airbnb fans—individuals with rental properties have a higher audit rate than those without. Rental revenues must be reported to the IRS and a variety of costs associated with renting property can be deducted. This is true even if only part of a property is rented, such as a room in a house, or if the property is only rented for part of the year. You can deduct expenses like mortgage interest, property taxes, listing fees, maintenance, utilities, and many other costs related to the rental. However, deductions must accurately reflect the proportion of the property rented and be prorated based on the number of days rented. It’s not uncommon for those with rental properties to report a loss, but repeated years of loss is a red flag. Documentation is vital for any person with rental property income and deductions.
You Have Assets or Cash in Another Country
The IRS has ramped up oversight of overseas assets and cash in recent years. You must report foreign accounts with a cumulative balance of more than $10,000. Foreign assets worth more than $50,000 must be reported. The IRS can access account information in a foreign bank if they feel a taxpayer might owe taxes on money kept there.
You Claim your Hobby as a Business
There are an array of deductions available to a self-employed taxpayer. However, expenses for a hobby are no longer deductible as of 2018. You can expect the IRS to notice if you switch an enterprise formerly classified as a hobby into a business. Likewise, any self-employment situation that consistently fails to produce a net profit. The IRS looks for proof that the taxpayer is putting is a significant amount of time and effort most days toward a business. If you are self-employed, be sure to maintain records to demonstrate your labors are geared toward income production.
If you are concerned the IRS may question your return or are concerned about any of the above tax situations, don’t despair. Most IRS inquiries are resolved by providing the IRS with additional information. Just be sure you are keeping required documentation. And if you need assistance, let us know. It’s also worth noting that the IRS randomly selects a small percentage of tax returns to review each year.
Steven Brettholtz is president of Myers, Brettholtz & Company, PA. His decades of accounting experience include numerous assignments in all phases of taxation for individuals, businesses entities and non-profit organizations. He is a member of the Florida, California, Hawaii, Nevada, New York Accountancy Societies, and the American Institute of Certified Public Accountants (AICPA).