6 Audit Red Flags the IRS Uses to Choose Which Returns to Audit

When it comes to your taxes, there are few things scarier than the prospect of a tax audit.

The good news is that most people aren’t audited.

Further, most audits are actually taken care of through the mail.  Many audits are routine, and require only that you send in a piece of missing documentation.

However, most people still prefer not to be audited at all.

As you prepare your tax return, consider the following 6 audit red flags that could lead to an increased chance of audit:

1. You Earn more than $1 Million a Year

Right now, the IRS is stepping up audits on those making more than $1 million.  For tax year 2010, one in eight millionaires were chosen for audit.  One of the red flags that is most common right now is how much money you make.  The more money you make, the more likely you are to be audited as the IRS attempts to crack down on tax evasions.

2. You Continually Report Losses on Your Business

At some point, if you want to keep deducting business losses against other income, the IRS expects you to claim a profit.

If you never turn a profit, the IRS considers what you do a hobby.

And, while you can deduct hobby expenses against hobby income, you can’t use your losses to offset other income, like you can with a business.  If you continue to report losses, and you don’t report profits, the IRS will be more likely to red flag your tax return for audit.

3. There is a Mistake on Your Tax Return

One of the most common reasons a tax return is picked for an audit is that there is some sort of mistake on the tax return.

This can be a mistake in claimed exemptions, a mistake in filing status, or a miscalculation.  If something doesn’t add up, your tax return will likely be held out for a closer look.

Before you file your tax return, look it over.  Even if you have an accountant prepare your tax return, it’s a good idea to look it over in order to make sure that everything is in over.

4. You Hand-Prepared Your Tax Return

The assumption, when you file a tax return you prepared by hand, is that there is more likely to be a mistake.

No matter how neatly you fill out your tax return, there is still the assumption that you might have made a mistake.  In an era when most returns are filled out using software (either by using retail tax preparation software or by an accountant using industry software), a handwritten tax return stands out.

If you do your own taxes, and prefer not to use tax prep software, you can use the free fillable forms offered by the IRS at IRS.gov.  You can fill the forms in, and then print them out; no handwriting required.

5. You Take a Large Number of Deductions or Credits for Your Income

Data crunching is a regular feature of IRS efforts right now.

Indeed, thanks to technology, nearly every industry is involved in data crunching in an effort to figure out what the “average” looks like.  Data collected over the years gives the IRS some insight into how many deductions, and what kinds of deductions, someone at your income level is likely to take, on average.

The same is true of credits.  If it looks like you are taking larger deductions and credits (or more deductions and credits) than your peers in the same income bracket, the IRS could decide to flag your return for an audit.

6. Your Refund is Larger Than Normal

Has your tax refund suddenly grown in size?

If your refund this year is much bigger than last year’s refund, the IRS might see that as suspicious.  It appears that you are trying to take extra deductions this year.

Additionally, if you normally owe on your taxes each year, but you suddenly have a refund, that could be grounds for an audit.  Sometimes, it helps to stop and consider what your tax return looks like to the IRS.

Stop Worrying About an Audit

While an audit is always a possibility, it doesn’t mean you have to worry about it all the time.

Indeed, there is no way to completely avoid an audit, since some are completely random.

However, if you keep good records, and you don’t claim any deductions or credits that you aren’t entitled to, there shouldn’t be much of a problem.  (If someone else has prepared your taxes, chances are that he or she will represent you, so that you don’t have to deal directly with the IRS.)

As long as you are above board with your tax return, and you have good documentation to back up all of your claims, you should be able to clear up most issues with the IRS fairly quickly.

Have you been audited? Do you think it was random or was there an audit red flag?