These Red Flags on Your 2020 Tax Return Could Spark Interest From the IRS
Filing your taxes can be annoying, but it can get even more annoying when you are under review by the IRS.
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Fortunately, your chances of getting an audit are slim - only 0.6% of individual tax returns filed for the 2010-2018 tax years have been audited against the latest IRS data. However, that small percentage still adds up to more than a quarter of a million accountants being audited. So if you are not careful, this can happen.
To help you be prepared, these are the red flags the IRS looks for when reviewing your tax returns.
Last updated: January 13, 2021
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Big charitable donations
"The IRS frequently identifies red flags through automated computer programs," said Nate Smith, director of the CBIZ MHM National Tax Office. “Almost all returns submitted to the IRS are analyzed by a computer program to look for an anomaly or a result that deviates from the norms. Under this program, each return is assigned a score known by the IRS as a DIF (Discriminate Function) score. The DIF score is used by the IRS to determine returns for testing. "
One factor that would negatively impact a DIF score is a charity contribution deduction that is disproportionate to your total income, Smith said.
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Mismatches between the reported income and the dates on your tax forms
Make sure the income you reported is exactly what is on your Forms W-2 and Form 1099. Mismatched events are seen as a red flag, Smith said.
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Error reporting cryptocurrency transactions
"The IRS has sent around 10,000 letters (in previous years) to taxpayers who have participated in virtual currency (bitcoin, etc.) transactions and have not reported any virtual currency related gains or losses," said Smith. "These letters offer taxpayers the opportunity to participate in a voluntary disclosure program if they discover that virtual currency transactions have not been included in previous tax returns."
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Business income and expenses that have gotten out of hand
"The IRS is always on the lookout for unreported income and high expenses," said Dave Du Val, chief customer advocacy officer at TaxAudit. "Self-preparers should be careful if employee and company expenses are accidentally doubled and lost in activities that might be more of a hobby than a business."
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Single prints that appear tall
"The IRS loves to pounce on people who report high individual deductions," Du Val said. "It's okay to have these legal deductions on your actual qualified expenses. Just make sure you have your records available to prove your position before filing your tax return. "
Du Val notes that 2017 was the last year that unreimbursed employee business expenses were allowed to be deducted from federal returns.
"(However) many states - like California - will continue to allow withdrawal, so it's still important to keep receipts," he said.
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Excessive rental costs
"Tax returns that appear to be excessive rental costs are often recorded on the IRS network," said Du Val. "Some of the deductions in Appendix E for rental income, which show rental income and expenses, are easy to misinterpret. Those who prepare their own tax returns should take the time to understand the deductions they are claiming. Failure to know the difference between a deductible expense and an expense that needs to be capitalized over several years can lead to an audit disaster. This is especially true if you are renting out a room to a roommate, as areas of common use are not allowed as rental areas. "
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When two people claim the same dependency, the IRS becomes involved.
"While separated and divorced parents who have custody have the clear advantage, they still have to prove everything by showing birth certificates, school records and more," Du Val said.
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Confusion when creating the status
Du Val said those filing with head of household status are interviewed a lot because the way you categorize loved ones with that status can be confusing.
“The (most recent) tax reform law has not made the rules easier to understand. In fact, under the Tax Cut and Jobs Act of 2017, there is a new $ 500 credit for what the IRS calls "qualified relatives" who are not necessarily people related to you, but certain tests exist and for which they are not entitled to the child tax credit, ”he said.
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A tax return suggesting taxpayers are not reporting enough income to support their lifestyle
If your expenses are high but the earnings you reported are not, that could be a red flag for the IRS.
"For example, a taxpayer seeking a deduction for mortgage interest on a million dollar mortgage (or the new $ 750,000 mortgage limit) and personal property taxes on expensive vehicles has a good chance of getting on the IRS's radar if his taxable." Income is not enough to cover these expenses, ”said Du Val.
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Indicate the exact correct ratio of income and expenses to qualify for a High Income Credit
A self-employment Schedule C that sets out exactly the "right balance" of income and expenses to qualify the taxpayer for a high earned income credit is a red flag, Du Val said.
"The available credit for a taxpayer whose income is below a certain threshold is up to ($ 6,660 for 2020)," he said. "Taxpayers who apply for EIC and whose tax return includes a Schedule C business form should be ready to provide evidence of all expenses and even the income listed on the tax return."
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199A Deduction for real estate rentals
Some individuals who claim this deduction do not qualify for it.
"To be eligible, the owner must have a concurrent written record showing that they have invested at least 250 hours of non-investor activity hours in the rental," Du Val said. reviewing records or preparing a tax return. Fulfilling this requirement does not automatically qualify a taxpayer to qualify as a “real estate specialist” for tax purposes or to exclude this income from the calculation of the net investment income tax (NIIT). "
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The law requires Americans with foreign financial accounts to report accounts to the U.S. Treasury Department even if they are not generating taxable income. Under the Banking Secrecy Act, if you have a financial interest in a signatory or other agency for one or more overseas accounts and the total value of all overseas financial accounts exceeds the value of all overseas financial accounts at any time, you must file a Foreign Bank and Financial Accounts (FBAR) report, according to the IRS $ 10,000 during the calendar year.
Failure to report these accounts can get you into hot water with the IRS. If you don't disclose overseas accounts, the IRS may still know about it, as foreign institutions are required to disclose US citizen account balances, CNBC reported.
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What to do when you are audited
Hopefully if you are aware of these red flags then you cannot be tested. However, if you hear from the IRS, here are some things you should do to prepare yourself.
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1. Gather all required documents
In order to defend yourself during a tax audit, you will need documents to substantiate your information in your tax return. The documentation you will need depends on what you are being examined for. However, it may include receipts, invoices, canceled checks, employee documents, legal documents, loan agreements, travel logs, medical or dental records, theft or loss documents, and company tickets or a K-1 timetable.
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2. Ask for help
The Taxpayer Advocate Service is an independent organization within the IRS that protects taxpayers' rights and assists with tax problems. If you are tested, you can contact service for help.
Most audits are carried out in writing. However, if you need to meet with an auditor in person, consider hiring an attorney or other lawyer to represent you.
"The best thing you can do if you are undergoing an IRS audit is to hire someone and authorize them to participate in the audit," said Paul Joseph, attorney, CPA and president of Joseph & Joseph, LLC. “Never go by yourself. In fact, my clients don't go at all. It is my position that I never let my clients come for an audit because they are expected to know all the answers right away. If the customer does not take the exam, they will have the opportunity to discuss the return with the employed professional and explain it in full before giving a response to the IRS. "
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This article originally appeared on GOBankingRates.com: Those red flags on your 2020 tax return could pique the interest of the IRS
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