IRS Audits for Incomes Below $200,000 Remain Constant at 1%

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For incomes over $200,000, the audit rates have increased by 50% over the past six years according to data recently released by the IRS. For those earning more than $1 million the audit rate has doubled during the same time. The Watson CPA Group explores the various reasons why tax returns are audited.

Tina Watson, CPA, MBA

several taxpayers are gaming the system for tax sheltering so self-employment income.. and most cases, self-employment losses.. is being scrutinized

IRS audits are simply a way of life, but understanding some audit trigger might minimize a taxpayer’s exposure:

Random: The percentage of random IRS audits is very low, but still exists.

Computer Scoring: All tax returns are scored by the Discriminant Function System (DIF). The system rates the potential for adjustments based on historical data and past IRS experience.

In other words, the IRS rates their ability to increase a taxpayer’s tax liability and subsequent tax due. The IRS is a business, and wants to earn a profit so-to-speak when committing resources.

The variables and formulas used to determine a DIF score is as secure as the Coke formula, but here are some focus areas according to other tax professionals and media outlets-

  •     Large Changes in Income: Historical data of income is maintained, and the IRS will check to see if the increase came from wages, capital gains, small business income, etc. Wages aren’t necessarily a concern, but other sources of income are.
  •     Self Employed or Small Business Losses: The IRS despises small business losses, and despises hobbies even more. Since history has demonstrated that several taxpayers are gaming the system for tax sheltering, self-employment income (and most cases, self-employment losses) is being scrutinized. Remember, the basic premise of a business is the reasonable expectation of earning a profit. If a taxpayer cannot prove the profit-earning premise a small business loss will be deemed a hobby and disallowed.
  •     Deductions: If itemized deductions such as mortgage interest or charitable contributions are outside the average for a taxpayer’s income range, an IRS audit could be triggered.. Don’t be afraid to take the deduction if it is legitimate, but ensure that it is allowed and keep good records.
  •     Rental Losses: This is a relatively new focus for the IRS since over the past few years several taxpayers are unable to sell their houses. While rental losses are fairly straightforward, it remains an area that the IRS is currently paying attention to.
  •     Home Office Deduction: Audits based on home offices have decreased slowly since telecommuting and self-employed taxpayers are becoming more common. Having said that, a lot of taxpayers still claim a home office deduction when it is clearly not allowed according to the IRS. Commonly a taxpayer will have another office where they perform substantial administrative or managerial activities, work at home a couple of days out of the week, and then incorrectly claim a home office deduction.
  •     Meals, Entertainment and Travel: These expenses have commonly been abused by past taxpayers, and the IRS has historical data showing their incredible success rate in disallowing these deductions and increasing tax liability.

Information Matching: Most W2s and 1099s are electronically transmitted to the IRS. If a tax return is missing a W2 or 1099, or if the amount reported is different than the amount the IRS has in their database, the tax return will be adjusted or audited.

Related Examination: If a business partner’s individual tax return is examined and a particular issue or transaction is discovered, other partners’ tax returns might be examined as well. This is not limited to business partnerships- any transaction or agreement between taxpayers that causes a taxable event on two different tax returns might trigger an audit if one tax return shows a discrepancy.

The Watson CPA Group is a progressive tax consultation and preparation firm embracing internet technology to provide worldwide tax service from offices in Colorado Springs, Colorado USA. A secure online Client Portal allows remote taxpayers to exchange financial information, tax documents and tax returns saving valuable time and resources.

Since 1997, The Watson CPA Group prepares individual and corporate tax returns for a flat fee, and specializes in LLCs, small business taxes, pilot and flight attendant tax deductions, rental property owners and expatriate tax clients.

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Tina Watson, CPA, MBA
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