Be aware of IRS audit red flags

Many taxpayers fear an IRS audit. Although the IRS audit targets change with the times, below you’ll find some of the high-risk tax-audit areas that the IRS has examined in recent years:

• Earned Income Tax Credit (EITC). The EITC is a tax credit designed for low-and moderate-income taxpayers. The more children you have, the greater your EITC will be. The IRS checks tax returns against the Federal Case Registry, and identifies custodial and non-custodial parents.  The EITC is the highest audited sector of the tax-filing population.

• Higher wages. The higher your income, the more difficult it is to escape the IRS audit radar. Some refer to this as the IRS “deep pocket” theory; each error or omission with the high-earner group will lead to higher returns of audit dollars.

• Large amounts of tax deductions. If your itemized tax deductions on your tax return exceed a target range as set by the IRS, the chances of being audited by the IRS increases. Nevertheless, you should take all valid tax deductions on your tax return if they are amply backed up.

• Appearance of the return. Don’t underestimate this factor. A carelessly prepared return that is incomplete or hard to read invites closer inspection.

• Use of too many zeros. A tax return that smacks of estimates (lots of zeros) is an open house for auditors. If you submit figures like $5,000 in auto expenses, $2,000 in gas mileage and $4,000 in lodging, it may look like you pulled these numbers out of thin air or inflated them by rounding.

• High DIF. When your tax return is filed, IRS computers compare it against the national Discriminate Information Function (DIF) average. Tax returns with the highest DIF scores are scrutinized to determine the best chance for collecting additional taxes upon audit.

• Self-employment. Self-employed Schedule C filers who report a business loss are likely to face more questions from the IRS. Also, the IRS believes most under-reporting of taxable income occurs among those self-employed; these individuals are audited by the IRS far more frequently than employees collecting a salary.

• Running a cash business. Small business owners, especially those in cash-intensive businesses, are tempting targets for IRS auditors. Experience shows that those who receive primarily cash are less likely to accurately report all of their taxable income.

• Automobile logs. One of the biggest and most audited items by the IRS for individuals in their own businesses, and employees of companies who use their car for business, is the tax deduction for business transportation. It is important that you keep good records of all tax-deductible automobile expenses and a mileage log showing business miles driven.

• Failing to report a foreign bank account. The IRS is interested in people with offshore accounts, especially those in tax havens. Failure to report a foreign bank account can lead to severe tax penalties.

• Using a shady preparer. If your tax preparer tries to convince you to claim deductions that sound too good to be true or doesn’t ask for receipts for deductions, find someone else. Be aware that you are responsible for the accuracy of the tax return

You should take every deduction you’re entitled to on your tax return, and you should not be frightened by the potential of an IRS audit. Substantiation and proof of deductions is the key to a restful night’s sleep.

Barry Lisak is an IRS enrolled agent specializing in personal and small business taxes for 30 years. Any questions can be directed to him at 516-829-7283, or mrbarrytax@aol.com.