Why and When an IRS Audit Could Happen to You

While uncommon, certain red flags increase the risks of receiving an IRS audit

It’s unlikely the IRS will audit you anytime soon. For the 2019 fiscal year, the organization only audited 0.45% of American taxpayers, a number equal to about one in every 220 people. One reason for this dip was a reduced budget for the IRS, as its 2018 allowance was about 20% lower than in 2010 when adjusted for inflation. 

However, the Biden Administration is looking to increase the IRS’ operating budget once again in a move that could see the number of people audited increase significantly. In 2010, 1.11% of taxpayers received audits, and a return to those numbers isn’t out of the question once the Internal Revenue Service has greater funds at its disposal. 

Of course, the odds of being audited depend on various financial factors, including income and tax reporting habits. Here’s a look at some things that could increase or decrease the odds of ending up on the receiving end of an IRS audit.

Making a mistake

Perhaps the most common reason people are audited is for making a mistake on their taxes. Even a simple error like a typo on your social security number or a simple math miscalculation could throw off an entire return, triggering an audit in the process. 

The good news is that you can typically fix a mistake quite quickly as long as you have the supporting documentation on hand. However, you’ll still have to deal with the hassle of the audit, so it’s best to avoid errors wherever possible.

High expenses or deductions

If you’re writing certain business expenses off, always keep receipts handy. Excessive travel, meal, and entertainment expenses could trigger an IRS investigation because there’s often a thin line between personal and business expenses. For example, if the IRS sees trends in your business expenses that don’t particularly match up with your company’s practices, they might ask for supporting documentation.

Claiming deductions that seem excessive for your income level could also raise suspicion. For example, if you make about $100,000 per year but claim $30,000 in charitable donations to reduce taxable income, you might be audited. 

Schedule C losses

Businesses are supposed to make money, so the IRS will want more information if you have losses on a Schedule C every year. A company should turn a profit three out of every five years at a minimum. If it fails to do so, the IRS considers the business a hobby, which changes the tax structure. 

You are permitted to have the occasional lousy year in business. But if you lose money consistently, you could have to explain it to the IRS and modify filings.

Missing some income

Generally, all income for regular employees should appear on a W-2. However, there are situations where individuals receive money for additional projects, side hustles, and other opportunities that won’t show up there. Those taxpayers have to fill out a 1099 form that reports this extra income to the IRS. An audit is likely if the government finds out about this income and you don’t claim it. 

Real estate losses

Property owners must be careful about reporting a loss when renting a home or office to a third party. The gist is that real estate is a passive activity, according to the IRS, so the amount of loss you can claim is limited. There is an exception, though, if you can prove that you’re a real estate professional. Qualifying as a professional involves working more than 750 hours per year in the industry. 

Underpayment

Failing to pay enough on your tax bill by the deadline can get you audited. The statement has a due date, but you can seek an extension by filling out Form 9465 with your return and agreeing to pay on an installment plan. Basically, if you can’t afford to pay your taxes, the IRS will demand to know why and may investigate your financial situation more thoroughly.

High income

While all of these situations could cause the IRS to audit you, the single biggest reason for these investigations is a high income. In 2015, for example, 8.16% of all individuals making over $10 million per year were audited. It doesn’t stop there, as an additional 4.39% of those earning between $5 million and $9.99 million were subject to investigations, too. 

Individuals making $1 million to $4.99 million in that year had a 2.39% chance of an audit, as did 1.13% of people with incomes between $500,000 and $999,999. 

Joe Biden’s American Families Plan includes $80 billion in additional funding for the IRS, most of which will be used to audit high earners in the coming years. Officials believe this plan could raise over $700 billion in additional tax revenue from these wealthy individuals over the next decade, so carefully planning their tax situations is an essential part of doing business.

Get tax planning and minimization assistance

You don’t want to overpay on your taxes. At the same time, it’s essential that you claim all your earnings and don’t give the IRS any reason to go after you. The best step is seeking a qualified tax planning and minimization service to legally keep more of your hard-earned money without running into issues with the government. 

Provident CPA & Business Advisors offers holistic business guidance to help our clients build great businesses and achieve financial freedom. We also provide proactive tax minimization services, ensuring you can reduce this expense legally and ethically. Contact Provident CPA & Business Advisors today for more information.