Know Your Audit Risk

Nearly every taxpayer can imagine a worst-case scenario where they run afoul of the IRS and are selected for an audit. Here are a few areas that tend to get unwanted audit attention and ideas to help you stay prepared.

Your audit risk is (probably) low. The first thing to remember is that the risk of having your tax return examined by the IRS is probably very low. The IRS audits less than 1 in 100 returns. If you are among the roughly 95 percent of Americans who make less than $200,000 a year, your chance of being audited is closer to 1 in 200. Audit chances rise dramatically the higher your income is above $200,000, according to the IRS annual Data Book.

Areas that get attention

Missing something. Aside from your income level, one of the biggest red flags for the IRS is a missing or incorrect tax form. Assume a copy of every official tax form you get also goes to the IRS. 

• Action: Create a list of all your expected tax forms. Check them off as you start to receive them over the next month or so. Immediately review the forms for accuracy. These include W-2s, 1099s, 1095s, 1098Ts and more.

Excessive deductions. Your risk of an audit increases when your tax return shows unusually high-value itemized deductions, such as charitable donations or losses from theft.

• Action: A legitimate deduction should always be taken. If your itemized deductions are high, make sure your proof of these deductions is well documented.

Large charitable donations. Your chances of an audit increase if you take large deductions for donations to charity, especially “noncash” donations of property with unclear value.

• Action: Always remember to file a Form 8283 for any donation above $500 in value. If you are donating anything at that value or higher, it may be worth paying for an appraisal of the value of the property so you can defend your deduction.

Disparities with your ex. Your tax return may as well have a red siren attached to it if you and an ex-spouse are not on the same page on claiming dependents, child support or alimony.

• Action: Ensure you and your ex-spouse are consistent in how tax items are treated on your separate returns. If you have had problems with this in the past, a quick phone call could save headaches for both of you.

Business activity. IRS agents have a keen eye for small business reporting, typically done on a Schedule C. In particular, the agency is quick to review claimed business activities they perceive as being hobbies.

• Action: Maintain detailed business accounts and record significant time spent on your business activity in order to demonstrate both professionalism and a profit motivation.