The Internal Revenue Service tends to keep mum regarding exactly what causes it to pluck one tax return from among millions with the intention of giving it a closer look. This doesn't entirely leave taxpayers in the dark, however. Tax professionals and statisticians routinely keep track of returns that result in audits and those that don't -- particularly when a filer is making a claim for a refund. Some trends exist, and one is that the IRS does not audit the vast majority of filers.
Many taxpayers are aware of the most common audit triggers: math mistakes, excessive charitable donations, and travel and entertainment deductions – to name just a few. Claiming a home office has a reputation for resulting in audits, and neglecting to report income for which the IRS received a W-2 or 1099 will almost certainly result in at least an inquiry from the IRS even if you're not claiming a refund. The IRS regularly compares all W-2s and 1099s it receives against taxpayers' returns.
The more you earn, the more likely the IRS is to audit you, especially if your return tells the IRS you're expecting a refund. Although the audit rate for all individual returns overall is only about 1 percent, if you take out those who earn less than $200,000, it jumps to 3.93 percent as of 2011. The rate climbs from there. One in eight taxpayers who earn more than $1 million annually are subjected to audits.
If you use your vehicle for business and claim a significant tax deduction for the expense, you could earn yourself an audit flag. Few individuals dedicate a vehicle solely to business driving and the IRS operates on the premise that some – if not most – of your miles are surely personal. Personal miles aren't tax deductible so if you claim that you use your vehicle for work 100 percent of the time, the IRS may question this and ask for proof.
Claiming Rental Deductions
The IRS has a lot of rules for deducting losses associated with renting real property. You can claim this deduction if you devote at least half your working hours – more than 750 each year -- to the real estate field or to managing your rental properties. You can also do it if you're a hands-on landlord, as long as your adjusted gross income doesn't top $150,000. Otherwise, passive loss rules apply and your costs of maintaining rentals don't qualify for a deduction. If you claim such losses, the IRS might want proof that you're qualified to do so.
If you own your own business – particularly if you're a sole proprietor or the sole owner of an LLC – the IRS might be more interested in your tax return. According to the Wall Street Journal, if you file a Schedule C with your return, the odds of you being audited are 10 times greater than those of S corporations. Businesses that routinely deal in cash transactions wave a red flag because the IRS reasons that such owners have a lot of opportunity to let some income go unreported. Even if you're meticulous about reporting every dime you earn, if you make a cash deposit to your bank account in excess of $10,000, the institution is obligated to alert the IRS that you've done so. The IRS uses such reports to zero in on returns that might warrant an audit. Yours might be suspect if you're claiming negligible income or a refund.
Taxpayers who maintain foreign bank accounts also interest the IRS. The rationale is that you might be tempted not to mention such assets under the belief that the IRS will have difficulty verifying such balances. This isn't necessarily true, and if you underreport or neglect to report such assets, you can leave yourself vulnerable to some stiff penalties. At the very least, you can expect the IRS to confirm that the information you've claimed in your return is accurate.
Beverly Bird has been writing professionally for over 30 years. She specializes in personal finance and w, bankruptcy, and she writes as the tax expert for The Balance.