Filing an income tax report is like walking on eggshells, do not be swayed by audit baits that will send the IRS knocking straight on your door. While the agency is reportedly having cuts in their budget, which would likely translate to fewer audits, that does not mean they are letting their guard down.
Now let’s walk through standard IRS tax filing errors and find out how you can steer away from committing the same mistakes.
1. Declare ALL of your income.
IRS does not rely on your honesty, according to the National Association of Enrolled Agents (NAEA), it uses an automated form-matching program that detects discrepancies between what you report and what is in their database.
Copies of form W-2 for the wages, as well as 1099s for interest, dividends and capital gains filed by independent contractors and freelancers, are also sent to the IRS. Always reflect these figures on your federal tax return or any discrepancies will trigger correspondence audit.
2. Don’t declare losses for extended periods, unless you can prove it.
Nobody is running a business for charity. It is understandable that new ventures need to recover the operation costs for a year or so before beginning to generate projected profits, and the IRS acknowledges this, but over declaring losses for an extended period will often sound the alarm for an IRS audit.
IRS tax attorney Garrett Gregory of Addison, Texas said: “report losses for three or more years and the agency will start to suspect ‘hobby lost’ cases” he said: “often calls for field audits which are in-person and more onerous than a correspondence audit.”
Be ready and keep records of your business expenses, document everything to prove you have a real business.
“You want to prove that you ‘breathed it, ate it, slept it, and drank it,’” Gregory added.
3. Anything Weird – Explain it.
Anything that looks off and questionable is among the IRS first red flags. Be the best judge, anticipate which of the entries would likely call for extra clarification, and provide it.
NAEA said insufficient net income, for example, warrants explanation and would require disclosure statement detailing how you managed to pull yourself off, either through savings, loans or credit cards.
4. Home Office Deduction Triggers.
Never report deductions for both office and home rental. Typically, your office is in one place, if not then explain it.
NAEA suggests that if your rental expense is for a business storage unit or equipment, it should be labeled property as ‘storage rental’ or ‘equipment rental.’
5. Report ALL Sales Incurred.
Bear in mind, the IRS has complete access to all necessary files and has programs that ultimately leave you no room to hide, either intentional or not, don’t leave anything out.
When you sell your home, the title company will send the IRS a 1099-S form, recording the proceeds from the sale. Even if the capital gains on the sale fall below the tax-exempt limits, it is still recommended to report the information on your return.
The same applies to the sale of mutual funds. Enrolled Agent Stephen DeFilippis of Wheaton, III said: “that in particular cases like selling a mutual fund bought before 2011 outside of tax-advantaged retirement account and reinvesting this in another mutual fund, must be reported or the IRS will assume the total proceeds from the sale are all taxable gains.”
6. Include Your Overseas Money.
If you think the IRS audit cannot sniff this, you are wrong. Under the new Foreign Account Tax Compliance Act (FATCA) foreign institutions will soon be sending this information to the IRS like any other bank or brokerage would in the United States.
If you fail to declare this income, penalties and back taxes will soon be crawling on your back.
7. Watch out for Mortgage Interest Deductions.
DeFilipis said: “when you co-own a house with your spouse, the lender sends you and IRS Form 1098, which records your mortgage interest during the year. However, often, this record also shows the social security numbers, should the person die, and the surviving partner tries to claim the mortgage interest deduction, it is already flagged.”
These tax audit red flags may come in handy; the key is to go over this carefully and declare everything, or better yet hire professional accountants in West Palm Beach to do the job for you.
For more information, please contact us.