Top 8 Tax Audit Triggers – Catching the Attention of the IRS
by Justin Moyer, North Carolina Tax Attorney
What is a tax audit? And what triggers it?
Let’s look into what may trigger the IRS to audit your tax return. The IRS and state tax authorities like the North Carolina Department of Revenue have authority under the law to examine your income tax return as well as any supporting documentation or other relevant data in order to verify the correctness of the return. That examination process is referred to as a tax audit.
Who gets audited? A big audit trigger is income level.
Determining who gets audited is based on several factors. We discuss the most common triggers of a tax audit that flag your return and alert the IRS in more detail below. First, let’s take a look at the probability of getting selected for an audit. One large determining factor is the amount of income reported. For those reporting zero income, 2% are likely to face an audit. Only half a percent of those reporting between $1 and $999,999 will likely be selected. According to IRS statistics, you are safest if your reported income falls between $25,000-$200,000.
Those reporting over one million dollars are the most likely to get audited. The IRS does not want to waste time or taxpayer dollars on an audit without a reasonable expectation of recovering additional tax money. This places the focus on the high earners.
Getting Flagged by DIF
The IRS operates a computer system called DIF – Discriminant Information Function- that is designed to detect anomalies in reported tax data. The IRS receives copies of forms like 1099s, W-2s, and other forms bearing identifying tax identification numbers like your Social Security numbers. This data is compiled and analyzed by DIF to identify discrepancies between what is reported by various entities and the information found on your tax return.
DIF then flags a human agent to review the data and determine next steps. The IRS has recently been subjected to budget cuts that will result in fewer audits than recent years.
If selected for an audit, there are 3 main methods of conducting the audit:
- Correspondence Audits (most common): These are conducted via mail requesting verification of information that can be provided by mail.
- Office Audits: These require the person subject to the audit to physically appear in an IRS field office and bring any requested documentation.
- Field Audit: These are typically reserved for more complex situations and result in an auditor or group of auditors coming onto your premises to investigate records.
Top 8 Triggers of a Tax Audit
- Income reported, as previously stated.
- Depositing more than $10,000 into a bank account. Banks report these transactions to the IRS so your tax return must reflect this income (if it is taxable income). The concept behind this reporting requirement is to thwart illegal activity.
- Claiming deductions that are too high in conjunction with reported income. DIF is on the lookout for deductions that are higher than the norm for your profession. This is the reason profession codes are entered onto tax returns.
- Operating a mostly cash business – like salons, bars, restaurants and car washes – places you under higher scrutiny. The IRS takes tips from concerned citizens regarding those who present a lifestyle and spending nature that far exceeds their reported income.
- Keeping assets in a foreign country is a huge red flag. Most foreign banks must provide lists of American account holders to the IRS. You are required to report foreign assets with a cumulative balance/value over $10,000.
- Claiming certain credits like the Earned Income Tax Credit or the Additional Child Tax Credit places you under more scrutiny. The government wants to ensure you are absolutely entitled to these credits.
- Mathematical errors can flag your return for audits, but most software eliminates this as a concern.
- For those filing business returns, not showing a profit for several consecutive years raises concerns over whether you are operating a legitimate business and may warrant a closer look.
What to Expect if Audited
The best way to resolve a tax audit is to be prepared. Get your documentation organized and be able to present it in a clear and concise manner. Maintain a proactive and cooperative attitude in your communications with tax authorities. Discuss your situation with the knowledgeable and experienced tax attorneys at Murray Moyer, PLLC. Whether you are facing a correspondence, office or field audit, we have in depth experience resolving tax audits with the IRS and NCDOR. Contact us today for a consultation.