Does the IRS Watch You? Uncover the Truth and Protect Yourself

The Internal Revenue Service (IRS) is responsible for enforcing the nation’s tax laws and collecting taxes. As part of this role, the IRS conducts audits to ensure that taxpayers are accurately reporting their income and paying the correct amount of taxes. While the IRS does not monitor every taxpayer’s every move, there are certain red flags that can trigger an audit.

IRS Audit Triggers

The IRS uses a variety of criteria to select tax returns for audit. Some of the most common audit triggers include:

• Math errors and typos: The IRS uses automated programs to check the math and calculations on tax returns. If your return “doesn’t add up,” it may be flagged for further review.

• High income: Taxpayers with high incomes are more likely to be audited than those with lower incomes.

• Unreported income: The IRS receives copies of your W-2s and 1099s, and their systems automatically compare this data to the amounts you report on your tax return. A discrepancy, such as a 1099 that isn’t reported on your return, could trigger further review.

• Excessive deductions: The IRS will compare your itemized deductions to the average total deductions for a given item claimed by other taxpayers who are in the same income range as you. A taxpayer whose deductions appear to exceed these averages may be further scrutinized by the IRS.

• Schedule C filers: The IRS particularly watches for businesses that operate primarily with cash – and almost certainly those that are reporting a loss. They have lots of experience auditing self-employed taxpayers who underreport income or overstate expenses.

• Claiming 100% business use of a vehicle: The IRS knows that it’s rare for someone to use a vehicle they own 100% of the time for business purposes. And, if you don’t have another personal vehicle registered in your name, it’s nearly impossible to report that the vehicle is exclusively used for business. Claiming 100% business use of a vehicle will almost certainly draw IRS attention.

• Claiming a loss on a hobby: Writing off expenses for a business is fine, but you can’t portray your hobby as a business. For it to be a business, you must have a reasonable expectation to make a profit. In general, the IRS will expect you to report a profit for three of every five years you operate the business.

• Home office deduction: To claim the home office deduction, you must use a portion of your home “regularly and exclusively” for business. Keep in mind that the IRS doesn’t see the dining room table as a desk! And having a TV in the “home office” could raise exclusivity questions. Most importantly, home office deductions from a person earning wages may draw increased attention, so make sure home office expenses are well-documented and supported.

• Deducting business meals, travel and entertainment: This is another area that draws IRS attention because of past abuse. First, it’s probably obvious that you can’t deduct expenses for which your employer reimburses you. Second, you must keep careful records – not just a receipt, but also a record of who was in attendance and the specific business purpose. The IRS doesn’t want you enjoying lavish meals and entertainment on Uncle Sam’s nickel.

• Earned income tax credit (EITC): The IRS estimates that 21% to 26% of EITC claims are paid in error. Some errors are unintentional, but the IRS scrutinizes EITC claims closely to prevent fraud. If you claim the EITC, make sure to document how you meet EITC rules so that you can provide this documentation to the IRS in the future, if needed.

• Dealing in cryptocurrency and other virtual currency: There’s currently less government regulation over cryptocurrencies like Bitcoin and Ethereum than over regular currency, which opens the door to potential fraud opportunities. The IRS has created a compliance campaign that’s focused exclusively on cryptocurrency transactions and also beefed-up enforcement to address abuse of virtual currencies.

• Taking early withdrawals from retirement accounts: These withdrawals must meet certain criteria in order to avoid taxation and penalties. Therefore, the IRS keeps an eye out for unreported early retirement account withdrawals that don’t meet the criteria and are therefore taxable.

How to Avoid an IRS Audit

While there is no surefire way to avoid an IRS audit, there are a few things you can do to reduce your chances of being selected:

• File your taxes accurately and on time. The IRS uses automated programs to check for errors on tax returns. If your return contains errors, it is more likely to be flagged for further review.

• Keep good records. The IRS may request documentation to support the claims you make on your tax return. If you are unable to provide the requested documentation, it could lead to an audit.

• Be prepared to answer questions about your tax return. If you are audited, the IRS will ask you questions about your tax return. Be prepared to answer these questions honestly and accurately.

What to Do If You Are Audited

If you are audited, don’t panic. The IRS is not trying to get you. They are simply trying to ensure that you are paying the correct amount of taxes.

Here are a few tips for dealing with an IRS audit:

• Respond to the IRS’s requests promptly. The IRS will send you a letter if you are audited. This letter will explain why you are being audited and what information you need to provide. Respond to the IRS’s requests promptly and accurately.

• Be cooperative. The IRS auditor will be more likely to work with you if you are cooperative. Answer their questions honestly and provide them with the requested documentation.

• Get professional help if needed. If you are not comfortable dealing with the IRS on your own, you can get professional help from a tax attorney or accountant.

The IRS does not watch every taxpayer’s every move. However, there are certain red flags that can trigger an audit. By being aware of these red flags and taking steps to avoid them, you can reduce your chances of being audited.