IRS Red Flags – And How to Avoid Them
Generally speaking you – or any person – have a 1 in 200 chance of being audited. This risk increases to 1 in a 100 if you make over $100,000 per year. Thankfully for most of us, the IRS has been forced to cut staff which means your odds of being audited just got a bit less likely. Even so, there are certain items in any tax return which the IRS considered “red-flags” as far as audits go. The number one red-flag is when it appears that your income doesn’t quite mesh with your lifestyle. The IRS routinely compares your stated income to your return from last year. Should there be a sizeable drop in income they may assume you are hiding money. They may also look at a huge mortgage as compared to your reported income and wonder where you are finding the money to live in such luxury. In other words, while minor variances are probably of little interest to the IRS, should you claim to be supporting six children and live in an upscale neighborhood on a stated income of $18,000 per year, you will likely have some serious explaining to do.
Cash Payments and Family Members as Employees
If you have your own business and hire your family members, you may have just raised another red flag. Of course hiring family members is not illegal, but many of the self-employed do it as a way of distributing money to their family while decreasing their overall tax liability. So, while you can certainly hire qualified family members to help out in your business—and pay them as you would any employee—you can’t distribute payroll to those who don’t actually work for you and you must always keep accurate and up-to-date payroll records. The next IRS red flag comes when you work in a profession which the IRS knows is often paid in cash. Unfortunately, whether you cheat on reporting your cash income or not, the IRS may assume that you do. If you work in a cash industry, then you may as well get ready to be audited at some point so keep meticulous records and, ideally, seek professional tax preparation advice.
Alimony Payments, Business Expenses and Overseas Income
If you receive alimony or spousal support payments those payments must be reported as income and if you pay spousal support you may or may not be able to claim a deduction for the money. The thing to keep in mind is that your return and your ex’s return must match up, or the IRS will step in. When you run your own business, you may find the ability to claim deductions at tax time a truly wonderful thing. Be aware, though, that common sense must be exercised at all times. Particularly in the area of your business vehicle, keep your deductions at the sensible level. Keep an accurate log of the driving you do for your business and only deduct that mileage. You may also raise IRS red flags if you show your business has lost money for several years in a row or if you have overseas income.
If you have doubts about your tax returns or if you think you are about to be audited, it is definitely in your best interests to speak with a highly experienced tax attorney who can steer you in the right direction and help you through an audit.