Are You At Risk For a Tax Audit?
Have you ever gotten something in the mail from the IRS? It’s kind of scary, isn’t it? Even if you’re sure you’ve done nothing wrong, just getting that letter seems to trigger an anxiety response, and makes you question yourself before you even read it: “Did I miss something?”
Sure, it’s a scary feeling, but the truth is that much of the time, they just want you to clarify a few things, or let you know that your tax calculation was, in their opinion, just a little off, one way or the other. But there are occasions when they want to do an actual examination of your accounts and your financial information to ensure that what you reported is correct according to the tax laws.
In other words, You’re being audited.
Overall, your chances of being audited by the IRS are pretty low. According to one report, Americans filed just over 157 million individual tax returns in fiscal year 2020 and the IRS completed about 510,000 audits, making your overall odds of being audited roughly 0.3% or 3 in 1,000. That’s fewer than half of those audited in fiscal year 2010.
So – what might trigger an IRS audit? Could be many things.
All tax returns go through the IRS computers and algorithms that compare your tax return against what they call “norms” for returns that are similar to yours. Thus, if your return looks statistically different, they’ll probably take a look at it. These algorithms are programmed for each tax season. In addition, some are just pulled at random just to see what’s up – the high school equivalent of a pop quiz!
Here are some situations outside of the computer review that could trigger an audit for you:
If you have a business partner or a fellow investor in a business that you are involved in and they get audited, the IRS may look at you as an audit candidate.
If you’re self-employed and your business reports nothing but losses over a period of several years, that will probably raise a red flag. They don’t mind losses for the first few years, but after that, it starts to look fishy.
If you’re in a high income tax bracket, you’re more likely to see an audit. Generally those with incomes of around $10 million or more tend to be looked at more carefully, but not always.
If you file late, or you don’t file a return at all, that may trigger an audit, especially if you’ve filed regularly for many years, or if the IRS has received 1099 or W2 or other information that showed you had an income for that year.
If you claim excessive deductions compared to others with similar income and circumstances, they’ll probably want to see some proof that they’re legitimate. These can be things like excessive mortgage deductions and unsubstantiated repair costs, or higher-than-normal charitable contributions that go against those “norms” that I mentioned earlier.
And of course, if you don’t report all of your income, it’s almost a sure bet that you’ll at least get a notice questioning why it’s not on your return, if not an outright audit. That’s kind of a no-brainer.
So it’s important to always make sure you report all of your income, especially investment income, which is sometimes easy to overlook if you’re not paying attention. I’m talking about things like capital gains, dividends, interest, stock-based compensation, independent contractor work – all of these are reported to the IRS via a 1099 form, which you should also receive. If the IRS has an unaccounted-for 1099, you’re almost guaranteed to hear from them.
Keep in mind, though, that being selected for an audit, or being asked to furnish further information, doesn’t always mean there’s a problem. If you’ve kept good records and you feel you’ve done nothing wrong, then you’re probably okay.
The best route, though, is the one that avoids an audit or correspondence in the first place. Many people aren’t aware of the rules regarding what’s taxable and what’s not, which is why we at Lucia Capital Group work hard to educate our clients on things like tax and risk management.
In next week’s video, we will talk about some of the best ways to avoid an IRS audit, and how you might be able to deal with one if that scary notice arrives in your mailbox.
Until then, happy filing!
Important Information:
The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
No client or prospective client should assume that this information, or any component thereof, serves as the receipt of, or a substitute for, personalized advice from Lucia Capital Group or from any other investment professional.
Rick Plum is a registered representative with, and securities and advisory services offered through LPL Financial, a registered investment advisor and member FINRA/SIPC. The investment professionals are affiliated with LPL Financial and are conducting business using the name Lucia Capital Group, a separate entity from LPL Financial.