Tax season might cause excitement if you're expecting a refund or dreading a hefty tax bill. But whether you're paying or receiving, you'll want to avoid the IRS flagging your return.
If you're trying to supplement your income by depending on your return, an audit can become especially stressful.
Audits are not entirely random and some scenarios increase your risk. But by knowing what they are, you might avoid them.
Filing your tax return is hard enough; the last thing you need is to have it come back to haunt you.
Taking a home office deduction
If your employer provides you with office space “at the office,” you can't claim a home office expense on your tax return while you are working remotely. This is true even if you use a room in your home exclusively for work.
You may be able to claim a home office deduction as a self-employed individual if you meet certain requirements. When determining the deduction, you may calculate the square footage of the office or the percentage of the home that qualifies.
Reporting a hobby as a business
Hobby and business income are reported in different sections, but many people confuse the two.
If you don’t intend to make a profit from your activities, your income might qualify as a hobby. This could help you avoid some self-employment tax.
However, you should take caution when reporting hobby income if you rely on the income, have profited from the activities for at least a few years, or expect to make future profits.
If there's any doubt as to whether your income is considered a hobby or business, consult a tax professional or use the best tax software you can afford.
Claiming too much in deductions
Claiming too many deductions can trigger an audit. Your return could become flagged if you claim more deductions than is typical or if your deductions seem disproportional to your income.
For example, if you claim to have made charitable deductions that were half your income, the IRS will likely become suspicious.
Tracking your expenses and contributions and keeping your receipts can protect you if the IRS questions your costs. You should never write off expenses that you can’t prove.
Having a foreign bank account
Having assets in foreign countries puts you at an increased risk of an IRS audit. But tax evasion has serious consequences, so it’s important to report these assets even though they might result in an audit.
According to the IRS, the Foreign Account Tax Compliance Act (FATCA) requires certain foreign institutions to report assets. So even if you fail to report the assets, that doesn’t mean the IRS won’t know about them.
Reporting a significant change in income
When your income changes significantly, whether as an increase or decrease, It could cause concern with the IRS.
While income that has decreased dramatically might indicate a taxpayer hiding some income, increased income can also create a greater audit risk. Returns for high-income earners also take more time to process.
If you didn't receive tax forms for payments in cash, you still need to report this income on your tax return. Keeping records and receipts of payments will help you prove your income if the IRS questions it.
Estimating business expenses
When possible, you should claim expenses as their exact amounts rather than estimating and rounding off.
An excess of expenses ending in rounded increments could result in an audit or the IRS questioning if your business exists.
It’s a good idea to get receipts for expenses, even when you pay in cash. This will help you keep track of the exact dollar amounts for all your expenses. If you ordered something online, be sure to download your invoice.
Large charitable donations
When you report charitable donations that seem very high compared to your income, the IRS might question their legitimacy. For example, if you make $30,000 per year, donating $10,000 seems an unlikely scenario.
Certain charitable gifts are also not deductible, such as gifts to an individual. When attending a charity event, only the amount donated above the fair market value of the item or event is considered deductible.
Combining business and personal expenses
You can only deduct expenses for your business. That means car repairs for your individual vehicles don't qualify.
Personal laptops or other supplies you use for personal purposes don't count as business expenses, nor can you count taking friends out to dinner as entertaining clients.
It isn’t difficult to mix up personal and business expenses when using the same credit card or bank account for both purposes. Having separate credit cards and/or bank accounts can help you better track expenses and keep them separate.
Tax laws are constantly changing, and a change in your financial circumstances could make the tax return process even more complex.
For instance, if you’ve made some smart money moves to increase your wealth and you now make more than you used to, your higher income will come with a higher tax bill.
No one likes audits, but the good news is that reporting accurately and having receipts to back up what you report can help you avoid them.
Filing a tax return can be difficult, but you want to be sure it’s over when you file and not followed by an audit. These are some ways to avoid an audit and even more taxpayer stress.