Audit Triggers and a Safety Catch

While the odds of hearing from an IRS auditor are still pretty low – a little more than 1% of returns get audited – there is a growing focus by the Service on doing more to close the tax gap. (In case you don’t know, the tax gap is the difference between what is believed to be the amount of taxes that should be collected vs. the amount that is actually collected.)  One area of concentration now is trying to better target auditees, hoping to give auditors a better collection rate.  In general there are two paths for nomination to the sampling pool that audits will be pulled from.  One is to make more than a million dollars a year. The other is to have entries on your tax return that are either associated with a high incidence of fraud or outside of the normal range for that particular item.

There are mitigation strategies for all of the above.  Today’s post will focus on the areas of your tax return that can act as audit triggers.  This topic is worth a multi-part post, so we’ll get to others later. First thing to remember is that the IRS’ most effective tool for closing the tax gap is third party reporting.  Any time you participate in an activity that is going to generate an informational return (1099 is the most common) that raises the chance your info will get a second look.  This extra attention is in response to a study that suggested 60% of under-reported income comes from self-employment.  If what you put on your return doesn’t match the informational return, you are going to hear from Uncle Sam.  It’s worth noting here that self-employment income isn’t the only way to get noticed in this manner.  Your bank and investment advisors are all required to disclose information about your activities with them.

This year the IRS is all over people who can claim an earned income tax credit and people who did take a home buyer credit.  In both cases, this is an easy issue to manage.  You’re either eligible or not.  If you can prove it, you’ve got nothing to worry about.  If you don’t have good paperwork start saving to pay the money back.  Depending on how much money is involved you may want to enlist help from a lawyer or accountant if you think you messed up on either matter.

Last but not even close to least for the start of this topic is if you file a Schedule C (sole proprietor) or Schedule E (rent or royalty income) you are the IRS equivalent of a scantily clad woman walking down the street.  Regardless of your intent – you are going to get noticed.  The way to minimize annoyance from the IRS version of a catcall is possession of good records.  If you have documentation to verify what you put on the return, you’re all set.  If you don’t, my recommendation is a visit to both your accountant and your local house of worship.