With “Tax Day” right around the corner, most people are scrambling to put together and file their 2010 tax return before April 18, 2011 (yes, the IRS has graciously provided us a few extra days this year). Accordingly, I have put together some information and pointers to help you decrease your chances of having the IRS audit your return.
“Red Flags” for Audit
Only one percent of all individual income tax returns filed each year are audited, and only three percent of returns for individuals makings $200,000 or more are audited each year. Although this number is far lower than most people think, there are a few common items known as “Red Flags” which draw attention to your tax return.
- Excessively High Itemized Deductions. If your deductions are disproportionately high compared to your income, then the IRS computer system will flag it for review. Generally, you should itemize your deductions in the following situations:
- If you do not qualify for the standard deduction, or the amount you can claim is limited.
- If you had large uninsured medical and/or dental expenses during the year. These can be claimed if they are in excess of 7.5% of your Adjusted Gross Income (AGI).
- If you paid interest and taxes on your home.
- If you had large unreimbursed employee business expenses or other miscellaneous deductions.
- If you had large uninsured casualty or theft losses.
- If you made large contributions to qualified charities.
- If you have total itemized deductions that are more than the standard deduction to which you are entitled.
- Non-Cash Charitable Contributions. If you have made non-cash contributions to a qualified charity in excess of $500, then you must fill out IRS Form 8283 in order to claim the deduction. This form itself will raise a red flag in the system. You will likely be required to provide supporting documentation of your donation from the charity.
- Home Buyer Credit. If you are claiming the Homebuyer Tax Credit, you must fill out your income tax return on paper and cannot file electronically. You must also include with the income tax return itself IRS Form 5405 along with additional documentation listed on that form. If Form 5405 and supporting documentation are not included in filing your original income tax return, then the credit may be disallowed and your return flagged for audit.
- Home Office Deductions. In order to claim this deduction, the area in your home used as your office must be used regularly and exclusively for the purpose of business. If the amount you deduct for your home office is disproportionately high (based upon the amount of square footage of the home itself compared to the amount of square footage of the office space), then your return may be flagged for audit.
- Job Expenses. In order to claim this deduction, the job-related expenses must exceed 2% of your Adjusted Gross Income (AGI) and must be expenses that have not been reimbursed by your employer.
- Rental Losses. Unless you are actively participating in in the business of renting properties as your business, it is most likely that the IRS will consider your rental properties as a source of Passive Rental Income or Loss. The Passive Loss Allowance maximum is $25,000; therefore if you attempt to claim Rental Losses near the $25,000 limit, then your tax return is likely to be flagged for audit.
- Small Business Losses. If you report losses on your small business, then you are highly likely to be audited. You must be able to prove these losses by documentation, and must also be able to prove that the business venture has been established legitimately to make a profit.
- Schedule C Business Expenses. If you report expenses of your small business, then you are highly likely to be audited. You must be able to prove ordinary and necessary business expenses by documentation and often by proof through physical inspection of the business facility, equipment, etc.
If you have further questions, please contact me for a consultation where I can review your return and tailor a tax plan to your specific needs.