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10 Red Flags the IRS Looks Out for When Reviewing Your Tax Return

Red Flags the IRS Looks Out for When Reviewing Tax Returns

The tax season can be stressful for many people. The fear of making mistakes on your tax return and getting audited by the Internal Revenue Service (IRS) can be overwhelming.

An audit is when the IRS examines your tax return to verify the accuracy of the information provided. The good news is that the vast majority of tax returns do not get audited.

However, there are some red flags that the IRS looks out for when reviewing a tax return.

Large Charitable Donations

Claiming large charitable contribution deductions on your tax return can raise a red flag. If you donated more than $5000 to a charity, you are required to file Form 8283.

The IRS may want to verify the donation with the charity to ensure that it was legitimate. Make sure that you keep proper documentation of your donations, including receipts and acknowledgment letters from the charity.

Failure to Report Cryptocurrency Transactions

The IRS treats cryptocurrency as property for tax purposes. If you bought or sold cryptocurrency in the tax year, you should report it on your tax return.

The IRS has been cracking down on taxpayers who fail to report cryptocurrency transactions. If you are unsure about how to report your cryptocurrency transactions, seek the advice of a tax professional.

Business Income and Expenses That Are Out of Whack

The IRS pays close attention to business income and expenses. If you are self-employed and report losses for several consecutive tax years, the IRS may consider your business to be a hobby.

They may disallow your losses and reclassify your business as a hobby. Make sure that you keep accurate records of your business income and expenses to avoid any issues with the IRS.

Itemized Deductions That Seem High

If your itemized deductions seem too high, the IRS may scrutinize your tax return. The IRS may request documentation to support your deductions, such as receipts, canceled checks, and credit card statements.

Make sure that you have proper documentation for all of your deductions, including legal allowable deductions.

Inflated Rental Property Expenses

If you own rental properties, the IRS may want to verify your rental income and expenses. Make sure that your rental areas and deductible expenses are accurate.

You should also ensure that you are not capitalizing expenses that should be deducted.

Dependency Issues

If you claim a dependent on your tax return, the IRS may want proof that the person is your dependent. Separated and divorced parents may both try to claim a child as a dependent.

The IRS will look at birth certificates and school records to determine who can claim the child as a dependent.

Filing Status Confusion

The head of household filing status can be confusing. If you are unsure whether you qualify for head of household status, seek the advice of a tax professional.

The Tax Cuts and Jobs Act of 2017 made changes to the rules for qualifying relatives.

Tax Return That Suggests Taxpayers Are Not Reporting Enough Income to Support Their Lifestyle

If your tax return suggests that you are not reporting enough income to support your lifestyle, the IRS may investigate. The IRS may compare your mortgage interest, personal property taxes, and other expenses to your taxable income.

If the numbers do not add up, the IRS may request documentation to support your income.

Reporting the Exact Right Ratio of Income and Expenses to Qualify for a Large Earned Income Credit

If you are self-employed and qualify for the earned income credit, you must report the exact right ratio of income and expenses to qualify for the credit. Make sure that you fill out Schedule C accurately and keep accurate records of your self-employment income and expenses.

199A Deduction for Real Estate Rentals

The 199A deduction for real estate rentals is a complex tax provision. If you own a rental property, you must keep a contemporaneously written log of your hours of rental services or hire a property manager.

A non-investor type of rental activity may also be required. Failure to comply with the rules could result in the loss of the 199A deduction.

You should seek the advice of a tax professional if you have questions about the 199A deduction.

Overseas Accounts

If you have foreign financial accounts, you must disclose them to the IRS. The Report of Foreign Bank and Financial Accounts (FBAR) is required for U.S. citizens who have financial accounts in foreign institutions.

Failure to comply with the FBAR reporting requirements can result in severe penalties.

Documenting and Seeking Help for a Tax Audit

If you receive a notice of audit from the IRS, do not panic. The first thing you should do is gather all necessary documents, including receipts, bills, canceled checks, employee documents, legal papers, loan agreements, trip logs, medical or dental records, theft or loss documents, business trip tickets, and Schedule K-1.

Proper documentation is key to proving the accuracy of your tax return. If you need help with a tax audit, you can contact the Taxpayer Advocate Service.

The Taxpayer Advocate Service is an independent organization within the IRS that helps taxpayers resolve tax-related problems and protect their taxpayer rights. You may also consider hiring an attorney or advocate to represent you during the audit.

If you choose this option, make sure that you attend the in-person meeting and provide any requested documentation. You may also consider attending a correspondence audit, which can be done by mail.

In conclusion, the best way to avoid an IRS audit is to ensure that your tax return is accurate and complete. Keep proper documentation of your income and expenses, and seek the advice of a tax professional if you need help.

If you do get audited, gather all necessary documents and consider seeking help from the Taxpayer Advocate Service or a tax professional. By taking these steps, you can minimize your chances of getting audited and ensure a smooth tax season.

In conclusion, tax audits are a cause for concern for many taxpayers. The IRS looks for red flags that may imply inaccuracies in a tax return, such as large charitable donations, failure to report cryptocurrency transactions, and business income and expenses that are out of whack.

Other areas the IRS scrutinizes include itemized deductions, rental property expenses, dependents and filing status, and reporting income and expenses for the earned income credit. Properly documenting all income and deductions and seeking help from a tax professional or the Taxpayer Advocate Service can help prevent an IRS audit.

The importance of keeping accurate records cannot be overstated, and seeking help can be the difference between a smooth tax season and a lengthy, stressful audit.

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