1. Forgettingto Report All Your Income
The IRS get a copy of ALL your 1099s and W-2s, andwhen that income is not reported on your tax return, the IRS computer notifiesan IRS human who usually sends a 2000-PC Notice, which is a more like a paperaudit.
All sorts of red flags go up when the 1099s and orW-2s don’t match the tax return that you file.
2. Claimingthe Home Office Deduction
The IRS appearsto be drawn to any return which takes advantage of a legal tax loophole in abig way. And claiming the Home OfficeDeduction can reduce your tax liability greatly.
The Home OfficeDeduction allows you to take a percentage of your rent, mortgage interest, home owners insurance, home improvements thatpertain to the home office, real estate taxes, utilities, and any otherexpenses which are
If you qualify,you can deduct a percentage of your rent, real estate taxes, utilities, phonebills, insurance and other costs that are properly allocated to the homeoffice. That's a great deal. However, to take this write-off, you must use thespace exclusively and regularly as your principal place of business. That makesit difficult to successfully claim a guest
· Taking Large Charitable Deductions
We all know that charitable contributions are agreat write-off and help you feel all warm and fuzzy inside. However, if yourcharitable deductions are disproportionately large compared to your income, itraises a red flag.
That's because IRS computers know what the average charitable donation is forfolks at your income level. Also, if you don't get an appraisal for donationsof valuable property, or if you fail to file Form 8283 for donations over $500,the chances of audit increase. And if you've donated a conservation easement toa charity, chances are good that you'll hear from the IRS. Be sure to keep allyour supporting documents, including receipts for cash and propertycontributions made during the year, and abide by the documentation rules. And attachForm 8283 if required.
· Claiming the Home Office Deduction
Like Willie Sutton robbing banks (because that'swhere the money is), the IRS is drawn to returns that claim home officewrite-offs because it has found great success knocking down the deduction anddriving up the amount of tax collected for the government. If you qualify, youcan deduct a percentage of your rent, real estate taxes, utilities, phonebills, insurance and other costs that are properly allocated to the homeoffice. That's a great deal. However, to take this write-off, you must use thespace exclusively and regularly as your principal place of business. That makesit difficult to successfully claim a guest bedroom or children's playroom as ahome office, even if you also use the space to do your work. "Exclusiveuse" means that a specific area of the home is used only for trade orbusiness, not also for the family to watch TV at night.
Don't be afraid to take the home office deduction if you're entitled to it.Risk of audit should not keep you from taking legitimate deductions. If youhave it and can prove it, then use it.
· The documentation rules. And attach Form 8283 ifrequired.
· Claiming the Home Office Deduction
Like Willie Sutton robbing banks (because that'swhere the money is), the IRS is drawn to returns that claim home officewrite-offs because it has found great success knocking down the deduction anddriving up the amount of tax collected for the government. If you qualify, youcan deduct a percentage of your rent, real estate taxes, utilities, phonebills, insurance and other costs that are properly allocated to the homeoffice. That's a great deal. However, to take this write-off, you must use thespace exclusively and regularly as your principal place of business. That makesit difficult to successfully claim a guest bedroom or children's playroom as ahome office, even if you also use the space to do your work. "Exclusiveuse" means that a specific area of the home is used only for trade orbusiness, not also for the family to watch TV at night.
Don't be afraid to take the home office deduction if you're entitled to it.Risk of audit should not keep you from taking legitimate deductions. If youhave it and can prove it, then use it.
· Claiming Rental Losses
Normally, the passive loss rules prevent thededuction of rental real estate losses. But there are two important exceptions.If you actively participate in the renting of your property, you can deduct upto $25,000 of loss against your other income. But this $25,000 allowance phasesout as adjusted gross income exceeds $100,000 and disappears entirely once yourAGI reaches $150,000. A second exception applies to real estate professionalswho spend more than 50% of their working hours and 750 or more hours each yearmaterially participating in real estate as developers, brokers, landlords orthe like. They can write off losses without limitation. But the IRS isscrutinizing rental real estate losses, especially those written off bytaxpayers claiming to be real estate pros. The agency will check to see whetherthey worked the necessary hours, especially in cases of landlords whose dayjobs are not in the real estate business
· Deducting Business Meals, Travel andEntertainment
Schedule C is a treasure trove of tax deductions forself-employed people. But it's also a gold mine for IRS agents, who know fromexperience that self-employed people sometimes claim excessive deductions.History shows that most underreporting of income and overstating of deductionsare done by those who are self-employed. And the IRS looks at bothhigher-grossing sole proprietorships and smaller ones.
Big deductions for meals, travel and entertainment are always red flags. Alarge write-off here will set off alarm bells, especially if the amount seemstoo high for the business. Agents are on the lookout for personal meals orclaims that don't satisfy the strict substantiation rules. To qualify for mealor entertainment deductions, you must keep detailed records that document foreach expense the amount, the place, the people attending, the business purposeand the nature of the discussion or meeting. Also, you must keep receipts forexpenditures over $75 or for any expense for lodging while traveling away fromhome. Without proper documentation, your deduction is toast.
· Claiming 100% Business Use of a Vehicle
Another area ripe for IRS review is use of abusiness vehicle. When you depreciate a car, you have to list on Form 4562 whatpercentage of its use during the year was for business. Claiming 100% businessuse of an automobile is red meat for IRS agents. They know that it's extremelyrare for an individual to use a vehicle solely for business, especially if noother vehicle is available for personal use. IRS agents are trained to focus onthis issue and will scrutinize your records if you make such a claim. Make sureyou keep detailed mileage logs and precise calendar entries for the purpose ofevery road trip. Sloppy record-keeping makes it easy for the revenue agent todisallow the deduction. As a reminder, if you use the IRS' standard mileagerate, you can't also claim actual expenses for maintenance, insurance and otherout-of-pocket costs. The IRS has seen such shenanigans and is on the lookoutfor more.
· Writing off a Loss for a Hobby Activity
Your chances of winning the audit lottery increaseif you have wage income and file a Schedule C with large losses. And if theloss-generating activity sounds like a hobby -- horse breeding, car racing andsuch -- the IRS pays even more attention. Agents are specially trained to sniffout those who improperly deduct hobby losses. Large Schedule C losses arealways audit bait, but reporting losses from activities in which it looks likeyou're having a good time all but guarantees IRS scrutiny.
You must report any income you earn from a hobby, and you can deduct expensesup to the level of that income. But the law bans writing off losses from ahobby. For you to claim a loss, your activity must be entered into andconducted with the reasonable expectation of making a profit. If your activitygenerates profit three out of every five years (or two out of seven years forhorse breeding), the law presumes that you're in business to make a profit,unless IRS establishes otherwise. If you're audited, the IRS is going to makeyou prove you have a legitimate business and not a hobby. So make sure you runyour activity in a businesslike manner and can provide supporting documents forall expenses
· guarantees IRS scrutiny.
You must report any income you earn from a hobby, and you can deduct expensesup to the level of that income. But the law bans writing off losses from ahobby. For you to claim a loss, your activity must be entered into andconducted with the reasonable expectation of making a profit. If your activitygenerates profit three out of every five years (or two out of seven years forhorse breeding), the law presumes that you're in business to make a profit,unless IRS establishes otherwise. If you're audited, the IRS is going to makeyou prove you have a legitimate business and not a hobby. So make sure you runyour activity in a businesslike manner and can provide supporting documents forall expenses.
· Running a Cash Business
Small business owners, especially those incash-intensive businesses -- think taxis, car washes, bars, hair salons,restaurants and the like -- are a tempting target for IRS auditors. Experienceshows that those who receive primarily cash are less likely to accuratelyreport all of their taxable income. The IRS has a guide for agents to use when auditingcash-intensive businesses, telling how to interview owners and noting variousindicators of unreported income
· Failing to Report a Foreign Bank Account
The IRS is intensely interested in people withoffshore accounts, especially those in tax havens, and the federal governmenthas had success getting foreign banks to disclose account information. The IRShas also used voluntary compliance programs to encourage folks with undisclosedforeign accounts to come clean -- in exchange for reduced penalties. The IRShas learned a lot from these programs and has collected a boatload of money($4.4 billion so far).
Failure to report a foreign bank account can lead to severe penalties, and theIRS has made this issue a top priority. Make sure that if you have any suchaccounts, you properly report them when you file your return
· reasonable expectation of making a profit. Ifyour activity generates profit three out of every five years (or two out ofseven years for horse breeding), the law presumes that you're in business tomake a profit, unless IRS establishes otherwise. If you're audited, the IRS isgoing to make you prove you have a legitimate business and not a hobby. So makesure you run your activity in a businesslike manner and can provide supporting documentsfor all expenses.
· Running a Cash Business
Small business owners, especially those incash-intensive businesses -- think taxis, car washes, bars, hair salons,restaurants and the like -- are a tempting target for IRS auditors. Experienceshows that those who receive primarily cash are less likely to accuratelyreport all of their taxable income. The IRS has a guide for agents to use whenauditing cash-intensive businesses, telling how to interview owners and notingvarious indicators of unreported income.
· Engaging in Currency Transactions
The IRS gets many reports of cash transactions inexcess of $10,000 involving banks, casinos, car dealers and other businesses,plus suspicious-activity reports from banks and disclosures of foreignaccounts.
A report by Treasury inspectors concluded that these currency transactionreports are a valuable source of audit leads for sniffing out unreportedincome. The IRS agrees, and it will make greater use of these forms in itsaudit process. So if you make large cash purchases or deposits, be prepared forIRS scrutiny. Also, be aware that banks and other institutions file reports onsuspicious activities that appear be designed to avoid the currency transactionrules (such as persons depositing $9,500 in cash one day and an additional$9,500 in cash two days later)
· Taking Higher-than-Average Deductions
If deductions on your return are disproportionatelylarge compared with your income, the IRS may pull your return for review. Butif you have the proper documentation for your deduction, don't be afraid toclaim it. There's no reason to ever pay the IRS more tax than you actually owe
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