Will Your Tax Return Be Flagged for an Audit?

by Miranda Marquit

One of the things our society fears most is the tax audit. Almost no one thinks that a tax audit would be fun. The good news is that the IRS only audits a little more than 1% of tax returns each year. Some of the audits are purely random — luck of the draw. There is no way to avoid a random tax audit. However, some audits are the result of tax returns that have raised red flags. If you want to avoid drawing closer scrutiny, there are some things that you can do.

Avoiding IRS Red Flags

One of the best things you can do to avoid an IRS tax audit is to check your tax return for errors. Errors in your math calculations can result in an audit — especially if the error is in your favor. Additionally, if you fill out your forms incorrectly, you might be red-flagged for an audit. And, there are still plenty of people who fill out their tax forms by hand. If your forms are sloppy or illegible, you could find yourself facing a tax audit. Here are a few more red flags that might initiate a tax audit:

  1. Home Office Tax Deduction: The IRS is very clear on deductions for the business use of your home. You can only take a home office tax deduction if the space is used just for your business. In my old home, my “office” was also used for storage. So, instead of using the whole room for a deduction, I could only deduct the 6 x 3 area that encompassed my desk and printer stand. Taking the home office tax deduction can be a red flag, since the IRS will want to look in whether you should really be taking that deduction.
  2. Big Tax Deductions: Thanks to data compiled over decades of tax returns, the IRS has a pretty good idea of the average amount of deductions taken by people in different income brackets. If you seem to be claiming more charitable deductions, and other deductions, than others at your income level, the IRS might red flag your tax return. Make sure you have all the documentation to back up your donations.
  3. Home Buyer Tax Credit: The home buyer tax credit offered recently is providing another opportunity for the IRS to more closely scrutinize tax returns. If you claim this tax credit, make sure you have all of the required documentation submitted. If you don’t, you could face a tax audit.
  4. Cash: Cash businesses, and large cash transactions, are also likely to mean scrutiny for your tax return. One thing you should realize is that cash transactions over more than $10,000 have to be reported by casinos, banks and others. This means that if you fudge on these numbers, the IRS could find you out. Businesses that operate using cash are also likely to be red-flagged for an audit. The IRS feels like cash businesses could be more likely to under-report their income.
  5. Mismatch with 1099s: Even if you don’t get a 1099 from someone you did work for doesn’t mean it won’t get sent to the IRS. Computers compare what comes in with what you report. If what you report is less than what your 1099s and W-2s say, you are likely to be audited. Understand, too, that starting this year, in 2011, PayPal and similar businesses will be required to report transactions on the 1099-k form. So keep good records.

If you are doing everything correctly, and you have the documents to back up your claims of credits, deductions and income, then there isn’t much to fear from a tax audit.

Published or updated January 21, 2011.
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{ 6 comments… read them below or add one }

1 Money Beagle

I’ve never been audited (knock on wood) but it’s amusing to hear stories from some of my financial adviser friends about how some clients are gearing up for their fourth audit in the last seven years. Yikes!


2 Ryan

I’ve never been audited either, but I make sure I keep everything that I claim on my taxes – thank goodness the IRS accepts scanned receipts! I use an accountant for my business and personal taxes and we make sure we don’t do anything that would be questionable. It’s just not worth the time or aggravation in my book!


3 Peter

I’ve never had to go through an audit, but one year i did receive a notice in the mail that we owed $800 more in taxes because 0f a mistake I had made on our taxes. Apparently I hadn’t claimed some unemployment income my wife had received by accident thinking it was from a previous year. The computers had noticed and flagged it. We paid and all was forgiven – no in depth audit.


4 krantcents

I was audited twice! They did not find anything, it was routine audit. I learned later that the CPA I used was on some list. I since switched CPAs. One of my main reasons, I use a CPA is to keep me out of an audit. I would be more aggressive in my itemized deductions.


5 john brennan

miranda,have you seen what PayPal is putting on these 1099k’sMy thought is the IRS is interested in income ,not mailing costs,ebay &paypal fees that are included on these 1099’s.My 1099K says i made $31K (which according to my Ebay seller reports is about $14K more than i really grossed,of which i really make between 20-25% profit(more like 4K)If pay pal had reported the money i received not including mailing costs paypal and ebay fees i wouldn’t have even got a 1099K


6 Miranda

Ah, the 1099-K. All sorts of fun this year. You’re right that it only show income, and doesn’t show your expenses. Anyway, you can deduct your costs against the income reported on your 1099-K. If you are a sole proprietor, this is done on Schedule C. If you have a LLC, you can do it on your Profit & Loss statement that you use with your business tax return.


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