There are many factors the IRS uses in its software to determine which returns get audited. Although it does not share trade secrets with the public, tax professionals know the IRS does take a close look at tax return deductions that are disproportionate with reported income.
The IRS issues many different statistics of income, including the national averages for various tax deductions for taxpayers at certain income levels. For example, tax filers who had an adjusted gross income (AGI) of $100,000 and itemized deductions claimed, on average, a charitable contribution deduction of about $3,000 (3 percent). Whether deductions are charitable or for something else, if you have clients claiming deductions above or below national averages, make sure they have documentation to support the expenses. Once the IRS looks at one area on the return, it may decide to expand the scope and examine other areas as well.
Note: You also have to be careful with the national averages the IRS publishes. For example, the national average for a property tax deduction is $5,250 for taxpayers with an AGI level of $150,000. A property tax bill of this size might be normal in California or New York, but may be high in other states with lower property tax rates such as Utah.
The following circumstances can increase your clients’ odds of getting audited by the IRS:
- Being self-employed (versus an employee) because of additional opportunities to make mistakes.
- Having a Form 1099 mismatch – for example, when income reported by brokerage firm doesn’t match tax return.
- Being a high income earner because the IRS earns a better rate of return.
- Claiming a large non-cash charitable contribution.
- Reporting a loss from a business activity that could be a hobby (no profit motive).
Editor’s note: For more information, check out other articles in Mike D’Avolio’s series on audits.