No one likes to get audited. It probably ranks somewhere between a root canal and having your e-mail account hacked on the misery scale. While only about 1% of all individual tax returns are selected, certain factors can bring your return under the IRS radar. Some may be unavoidable, such as the nature of your business, but here are a few red flags you can avoid:
- Claiming Deductions on a Side Job
Suppose John earned $100,000 as a full time employee at a photography studio. He also ran a wedding photography business on the side that earned $45,000. If he deducts expenses against his side income, the IRS will suspect that those expenses are really attributable to his employee income from the studio and it may trigger an audit. To avoid an audit, John should take several steps to make sure that the business appears to be a bona fide photography company. Schedule C, Trade or Business Income, should indicate his business address and not the same address as his home address on the front of the return. It should have a distinct business name, such as “John’s Hot Shots,” rather than putting it under his name “John Smith ”. He should add as much detail as possible to the business deductions. It would also be wise to maintain a website for the side business, as well as business cards. Even with the above precautions it is critical to document everything and maintain good records, as the risk of audit, albeit reduced, is still there.
- Mortgage Interest Deduction Without a Form 1098
If you borrowed money for a mortgage from an individual or a foreign bank instead of a U.S. bank, and are therefore not given a Form 1098 with the interest expense amount, you must be careful to enter the expense on the right line. In Schedule A, the form for itemized deductions, there are two separate lines for mortgage interest expense; one for interest reported on Form 1098 (line 10) and the other for interest not reported (line 11). If you put unreported interest on the line for reported interest, the IRS will immediately see that their records do not match your claim.
- Always Report Sale of Home
A mistaken assumption many people have is that if they sell their home at a loss, or the sale is not taxable for another reason, they don’t have to report it. While the sale may not cause a tax liability, the seller’s attorney always issues a Form 1099-S, which informs the IRS of the proceeds. Neglecting to report it will likely trigger an audit, even if no taxes are actually due.