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21 IRS Audit Red Flags

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You may be wondering about your chances that the IRS will audit your return. Most people can breathe easily because the vast majority of individual returns escape the audit machine. The IRS audited only 0.4% of all individual tax returns in 2019. Over 70% of these audits were handled solely by mail, meaning taxpayers never met with an IRS agent in person. And the individual audit rate was even lower for 2020.

But this doesn't mean it's a tax cheat free-for-all. The bad news is that your chances at the unenviable audit lottery escalate (sometimes significantly) depending on various factors, including the complexity of your return, the types and amounts of deductions or other tax breaks you claim, whether you're engaged in a business, or whether you own foreign assets. Math errors could also draw an extra look from the IRS, but they usually don't lead to a full-blown exam. In the end, there's no sure way to predict an IRS audit, but these 21 red flags could certainly increase your chances of drawing unwanted attention from the IRS.

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The IRS gets copies of all the 1099s and W-2s you receive, so be sure you report all required income on your return. IRS computers are pretty good at cross-checking the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill that the IRS will mail to you (these letters don't count as audits for purposes of the IRS's 0.4% audit rate). If you receive a 1099 showing income that isn't yours or listing incorrect income, get the issuer to file a correct form with the IRS.

Report all income sources on your 1040 return, whether or not you receive a form such as a 1099. For example, if you get paid for walking dogs, tutoring, driving for Uber or Lyft, giving piano lessons, or selling crafts through Etsy, the money you receive is taxable.

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The overall individual audit rate may only be about one in 250 returns, but the odds increase as your income goes up (especially if you have business income). IRS statistics for 2019 show that individuals with incomes between $200,000 and $1 million had up to a 1% audit rate (one out of every 100 returns examined). And 2.4% of individual returns reporting incomes of $1 million or more were audited in 2019.

The IRS has been lambasted for putting too much scrutiny on lower-income individuals who take refundable tax credits and ignoring wealthy taxpayers. Partly in response to this criticism, very wealthy individuals are once again in the IRS's crosshairs.

And if President Biden gets his way, more upper-income individuals will be audited. He wants Congress to give the IRS billions of dollars over 10 years for the agency to step up its enforcement efforts against wealthy individuals, large corporations and passthrough entities, such as partnerships and LLCs. The Treasury Department says that the president's proposal won't cause audit rates to rise for individuals with incomes below $400,000.

We're not saying you should try to make less money — everyone wants to be a millionaire. You just need to understand that the more income shown on your return, the more likely it is that the IRS will be knocking on your door.

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If the deductions, losses or credits on your return are disproportionately large compared with your income, the IRS may want to take a second look at your return. Taking a big loss from the sale of rental property or other investments can also spike the IRS's curiosity. Ditto for bad debt deductions or worthless stock. But if you have the proper documentation for your deduction, loss or credit, don't be afraid to claim it. Don't ever feel like you have to pay the IRS more tax than you actually owe.

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We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag.

That's because the IRS knows what the average charitable donation is for folks at your income level. Also, if you don't get an appraisal for donations of valuable property, or if you fail to file IRS Form 8283 for noncash donations over $500, you become an even bigger audit target. And be sure to keep all your supporting documents, including receipts for cash and property contributions made during the year.

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If you've donated a conservation or façade easement to charity, or if you are an investor in a partnership, LLC or trust that made such a donation, chances are very good that you'll hear from the IRS. Battling abusive syndicated conservation easement deals is a strategic enforcement priority of the tax agency. Revenue agents are targeting promoters, taxpayers, preparers and advisers. As a result of the IRS clamping down, there are about 100 syndicated easement cases on the Tax Court's docket.

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Schedule C is a treasure trove of tax deductions for self-employed people. But it's also a gold mine for IRS agents, who know from experience that self-employed people sometimes claim excessive deductions and don't report all their income. The IRS looks at both higher-grossing sole proprietorships and smaller ones. Sole proprietors reporting at least........

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