The IRS has released new statistics on audits for 2010 and your chance for an audit is the highest it has been since 1997. For individual returns, 1.11% of all returns were audited. For upper income earners, the statistics were even worse. Filers with income between $200,000 and $1 million were audited at twice that rate, and filers with over $1 million were audited at a whopping 8.36%. That means about 1 in 12 of those high incomers.
While some audits are random, others have recognizable triggers. Kiplinger has a list of twelve missteps that can help trigger an audit here. Some of them deserve special attention.
The number one trigger is failing to report all of your income. With the emphasis on matching 1099 forms and the ability of IRS computers to cross check your return with what has been sent in, the IRS is sending out many CP2000 Notices to correct taxpayers on under-reported income. Sometimes this means a missing brokerage statement, other times it can be as simple as forgetting to report that bank interest on your personal savings account. If the IRS gets a 1099 for you that is wrong, you will have better luck fighting that out with the original issuer than you will with the IRS.
Deductions for use of your home office are a great benefit, but these also are a great audit trigger. I have a home office, but I don’t claim it. Why? Because my “home office” consists of a corner of the table in my dining room where I can rest my laptop, see the tv, and not be secluded from my family. When dinner time rolls around, the laptop goes away and the place mat comes out. I am not using the space exclusively for business purposes, and if I did claim it the IRS would disallow it. People who set up a desk in the kids room, use the den for a part-time office, or stick a desk in the corner of their bedroom and write off the square footage of the desk will have a hard time keeping this deduction if they are audited.
Do you really use that vehicle 100% for business? Sure, every good salesman should be driving a Mercedes convertible sedan to wow their clients. But don’t you take it to the beach on weekends too? The IRS is cracking down on businesses who claim 100% business use for vehicles. This is especially true if you have no other vehicle for personal use, and what type of vehicle it is. Your claim may be legitimate. You might leave the convertible at the office and take your second car to the beach on the weekends. The best way to keep this deduction is to keep good records. Don’t fear an audit if you have a well kept mileage log.
And the last tip I want to highlight here is hobby losses. It is a great temptation to report hobby income as business income and write off expenses against it. However, the IRS will look closely at these businesses to make sure they actually have a business purpose to make profit. If you make a profit three out of five years, you generally shouldn’t have any difficulty. If not, you may need to prove your profit motivation and business purposes. This is more of a gray area and can get you into trouble with the IRS, especially if you don’t have good representation. The IRS is stingy with hobby losses and only allows you to report losses equaling up to your income. Not only that, but those losses must be itemized and are subject to the 2% of AGI floor. In other words, hobby income will never be a complete wash with your losses.
As always we are here to help. If you have any questions or would like to review your particular situation for risk of audit. Please don’t hesitate to call.