Money Matters
presented by: Vision Financial
No one wants to see an Internal Revenue Service (IRS) auditor show up at his or her door. The IRS can’t audit every American’s tax return, so it relies on guidelines to select the ones most deserving of its attention. Here are six flags that may make your tax return prime for an IRS audit.¹
- The Chance of an Audit Rises with Income. According to the IRS, less than 1% of all individual taxpayer returns are audited. However, the percent of audits rises to nearly 4% for those with incomes between $500,000 and $1 million, and is over 8% for those making between $1 million and $5 million.²
- Deviations from the Mean. The IRS has a scoring system it calls the Discriminant Information Function that is based on the deduction, credit, and exemption norms for taxpayers in each of the income brackets. The IRS does not disclose its formula for identifying aberrations that trigger an audit, but it helps if your return is within the range of others with similar income.
- When a Business is Really a Hobby. Taxpayers who repeatedly report business losses increase their audit risk. In order for the IRS not to consider your business as a hobby, it needs to have earned a profit in three of the last five years.
- Non-Reporting of Income. The IRS receives income information from employers and financial institutions. Individuals who overlook reported income are easily identified and may provoke greater scrutiny.
- Discrepancies Between Exes. When divorced spouses prepare individual tax returns, the IRS compares the separate submissions to identify instances where alimony payments may be deducted on one return, while alimony income goes unreported on the contra party’s return. Another common tripwire is when both former spouses claim the same dependents.
- Claiming Rental Losses. Passive loss rules prevent deductions of losses on rental real estate, except in the event when an individual is actively participating in the property’s management (deduction is limited and phased out), or with real estate professionals who devote greater than 50% of their working hours to this activity. This is a deduction to which the IRS pays keen attention.
Heath Morris, CFP®
Vision Financial Group
4505 Pine Tree Circle, Birmingham, AL 35243
205-970-4909, www.vision-financialgroup.com
- The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation.
- IRS, 2016
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