10 Tax Filing Mistakes That Might Trigger an IRS Audit (and How to Avoid Them)
Filing your tax returns can be overwhelming, especially when you’re preparing your return on your own. Many of us worry about getting audited by the IRS due to accidentally providing the wrong information, misreading a line on a form, or simply feeling unsure about some of the financial information you’re providing. Unless you’re an accountant or seasoned tax pro, the IRS jargon can be confusing and hard to decipher.
If you want to make sure your taxes are 100% accurate this year, I’ll run you through how often tax auditing happens, how the process works, and some of the most common auditing mistakes Americans make (and how to avoid them!).
- How many people receive a tax audit each year?
- What happens if you are audited?
- 1) You forgot to report all of your income
- 2) You deposited a lot of cash throughout the year
- 3) You’re self-employed and claimed deductions
- 4) You itemized your deductions
- 5) You work from home
- 6) You earn income from investments
- 7) You claimed the EITC (Earned Income Tax Credit) or Additional Child Tax Credit
- 8) You have cash or assets in a foreign country
- 9) You claimed large donations, but have a low income
- 10) Rounding up deductions
- The bottom line
How many people receive a tax audit each year?
In the past decade, the number of Americans being audited has decreased significantly. Ten years ago, 1 in 90 people was likely to get audited, whereas today, the numbers are closer to 1 in 220. In fact, only 0.45% of Americans were audited in 2019, which decreased since 2018 when 0.59% of Americans were audited.
The truth is, the IRS is more likely to audit you if you have a high AGI (adjusted gross income). In 2018, for instance, 0.54% of tax returns were audited for those earning between $50,000 and $75,000. However, 6.66% of returns were audited for those earning over $10 million per year.
If you’re a low-to-mid-income earner, you have less of a chance of being audited, though it is still possible.
In addition to income, the IRS also determines who will be audited using a computer program called DIF (the Discriminant Function System). This program will select candidates most likely to have tax return issues and even flag areas the IRS should review.
important: Only 0.54% of tax returns were audited for those earning between $50,000 and $75,000 in 2018.
What happens if you are audited?
While being audited by the IRS sounds scary, having your tax returns audited simply means the IRS is reviewing the financial information you provided to ensure everything is accurate and nothing has been misreported, underreported, or left off. If you’re filing a simple tax return, in most cases, there’s little need to worry about an IRS audit ending badly.
If you are audited and the IRS finds your tax return contains some inaccuracies, in most cases, you’ll receive a tax bill (with interest and late-payment penalties) to pay. This could come from the federal government, state government, or both. Once you pay the bill, there are no further actions needed to resolve your audit.
However, if the IRS suspects you of fraud, your audit can become more serious. In cases like these, it’s best to turn over all of your financial records, contact your account or a tax professional, and seek legal counsel if you have any questions about how to proceed.
How to reduce your chances of an IRS audit
The good news is, there are steps you can take when filing your 2020 tax return to reduce your risk of being audited whether you’re filing on your own, using tax software like TurboTax, or working with a CPA (certified professional accountant) preparer.
These are the most common tax filing mistakes, and the ways to avoid them:
1) You forgot to report all of your income
By law, your employers are required to issue W-2s for all employees. These numbers are also reported to the IRS. If you’re a freelancer or independent contractor, you’ll receive a 1099-MISC (now replaced with the 1099-NEC) if you earn over $600. Reportable Income also includes cash tips and wages, interest and dividend income, and casino winnings.
If you’re a freelancer, for instance, it’s important to keep track of your earnings throughout the year, not only so you can pay estimated taxes, but also so you can keep track of the clients you earned income through. It can be easy to forget a one-time assignment or job, so using accounting software or having a separate bank account for all freelance income can help you keep your freelance earnings separate.
Overlooking even one small source of income can cause DIF to flag your file with the IRS, leading to a full audit.
2) You deposited a lot of cash throughout the year
It’s important to keep records of where any cash income comes from throughout the year (whether earned or gifted). The IRS is notified anytime an individual or business deposits more than $10,000 in cash in a banking account. When filing your tax returns, you’ll need to account for this income. Failure to do so can lead to an IRS audit.
important: The IRS is notified anytime an individual or business deposits more than $10,000 in cash in a banking account.
The IRS keeps a close eye on large cash deposits in order to survey illegal activities. As long as you have proof of where the money came from and can show it was earned legally, you’re in the clear.
Banks will also monitor large deposits close to this amount to ensure you’re not structuring your deposits. For instance, depositing $9,000 one day and $1,000 the next would still ensure your activity is flagged.
3) You’re self-employed and claimed deductions
When you’re a freelancer, business owner, or otherwise self-employed, you’ll be able to write off some of the business expenses you paid throughout the year to manage your self-employment. However, DIF is always looking for any expenses above typical business thresholds, depending on your profession.
For instance, if you’re a freelance travel writer, you’re more likely to have travel, mileage, meal, and entertainment expenses than a local construction contractor. The DIF is aware of the average deduction rates most self-employed individuals claim, depending on their professions, and is likely to flag your tax return if you exceed this threshold.
Of course, every business is unique and you might have higher than average deductions. If this prompts an audit, just make sure you have bank statements and records of everything you’ve claimed.
4) You itemized your deductions
Most individuals opt to take the standard deduction when filing their tax returns, particularly if they are filing simple returns and have no self-employment income to report. Whenever you’re itemizing deductions, it’s important to double-check all reported deduction amounts to ensure you’re not misrepresenting your income.
If the IRS sees you’re claiming deductions for a large portion of your income, it’s likely to raise a red flag. If you have any questions about a deduction when filing, you should always reach out to a CPA or tax professional. Even online software services like TurboTax and H&R Block allow you to connect with tax experts.
important: Many Americans are not eligible to claim a home office.
5) You work from home
Many of us experienced what it was like to work from home for the first time during the pandemic. If you’re one of the millions of Americans who began working remotely, you might have heard about the home office deduction. This deduction allows you to claim the space you worked in as an itemized expense — but unfortunately, many Americans are not eligible for this tax break.
In order to claim a home office as a deduction, this space must be a separate room or designated area in your house that is only used for work. It must also be your primary place of work. On top of this, you can only claim your home office as a deduction if you’re self-employed or own your own business. Remote employees working for employers are not eligible to claim this deduction.
There are other requirements to be aware of as well when claiming this deduction. Make sure you meet them all or the IRS is likely to flag your tax return.
6) You earn income from investments
Many Americans forget to report investment income when filing their tax returns. While this may be an innocent mistake, it’s one that’s likely to result in an audit. If you have investments, you should receive 1099 forms in January or February. These forms are also sent to the IRS.
The good news is, if you overlook an investment where you received income or dividend funds, the IRS is more likely to send you an adjusted tax bill to pay. If you pay this on-time, you’re less likely to be audited. Still, it’s always a good idea to double-check any investments you’ve made to determine if you received income during the previous tax year.
7) You claimed the EITC (Earned Income Tax Credit) or Additional Child Tax Credit
Claiming the Earned Income Tax Credit (EITC) or Additional Child Tax Credit almost always leads to an audit, but you won’t necessarily be aware this is happening. Since claiming either one of these credits comes with income limitations and the return increases with each dependent you claim, the IRS needs to review your tax return to ensure the information is 100% accurate. Only then will they begin issuing you a check for the difference you are owed.
This means your tax return is more likely to be issued after mid-February.
8) You have cash or assets in a foreign country
Whenever you note that you have cash or assets in other countries, the IRS becomes more interested in your tax return. This is because the federal government wants to make sure you’ve paid the full amount of taxes due on your income, rather than trying to circumvent tax laws by stashing your money overseas.
By law, you must report any foreign accounts that you hold with balances over $10,000 using FinCEN Form 114. If you have any foreign banking accounts that hold more than $50,000, you’ll need to list this on the IRS Statement of Specified Foreign Financial Assets (Form 8938).
Following these steps will ensure you follow the proper procedure when filing your tax return, but don’t be surprised if the IRS audits you to confirm this information.
9) You claimed large donations, but have a low income
Whenever you’re claiming a large write-off, deduction, or credit, but have a low-income, the IRS is more likely to flag your tax return. The IRS currently allows taxpayers to claim charitable donations on their tax returns and offers them a tax break on the amount donated. Whenever you claim this deduction, it’s important to have a record of your charitable donations and the exact amount contributed.
For instance, if you claim you donated $40,000 in donations, but you only earn $55,000 per year, DIF is most likely going to flag your return. Make sure you can fully account for any charitable donations before deciding to claim them on your taxes.
10) Rounding up deductions
When itemizing deductions as a small business owner or freelancer, it can be tempting to round up numbers. Maybe you don’t remember exactly how much you spent on your new laptop, but you know it was around $1200. It might seem harmless to estimate your expense costs on your tax returns, but this is another red flag DIF often notates. Since we rarely spend exact dollars and no cents on items, the IRS’s computer system is designed to highlight instances where deductions are rounded.
It’s essential that you put the exact amount of any claimed expense when filing your tax returns. Even if it’s $1,201.18, claiming $1,200 can lead to the IRS auditing your entire return because of one simple estimation.
The bottom line
Filing your tax returns accurately and on-time every year is a responsibility every taxpayer must take on. It’s important to seek professional tax assistance if you have any questions when completing your return and to report all income earned in a given tax year. Make sure you’re eligible for deductions and credits before claiming them and always list the exact amount of any itemized deductions. Lastly, be sure you have financial records to back up the information on your tax returns.
Being audited may sound scary, but in most cases, if a number was mistyped or taxes were underpaid, the IRS will simply send you a corrected tax bill to pay. Still, it’s important to double-check your tax information before submitting it to avoid any unexpected surprises from the government.