Everyone dreads the idea of a tax audit. And luckily, almost no one gets one.
Only 0.2% of taxpayers who made less than $1 million in 2021 were served an audit notice from the Internal Revenue Service, according to the most recent IRS Data Book. That’s about 1 in 500 people.
Those who are audited tend to make specific, but common, mistakes that raise red flags at the IRS. Here are three to watch out for — and what you can do to avoid them.
1. You don’t report all of your income
If you receive income from multiple sources, the IRS expects you to report all of it.
Anyone who distributes money to you over the course of the year, from employers to brokerage firms, sends copies of your tax documents — such as W-2 and 1099 forms — directly to the IRS. If your tax return doesn’t match what the IRS receives, it could raise alarm bells, Daniel Geltrude, a certified public accountant and founder of Geltrude and Company LLC, told CNBC in 2023.
“Maybe [you] didn’t see the 1099, but the IRS got it,” Geltrude said. “Now there’s not a match. Here we come.”
A 1099 form confirms how much you owe in taxes from the pay you received doing freelance, contract or gig work, or for a number of different types of ad hoc payouts. There are several types of 1099 forms. They operate like W-2 forms, but with one key difference: You may receive a 1099 in mid-to-late February, later than most W-2 forms, which employers are required to send out by Jan. 31.
To avoid falling short in reporting all of your income, it’s important toconfirm that you have received all 1099 forms before you submit your tax return to the IRS. This may mean contacting your income sources directly at tax time or keeping track of all sources of income you receive throughout the year.
2. You claim large or unusual deductions
Claiming unusually high deductions can trigger an IRS audit, according to Geltrude.
Common deductions include donations to charity, student loan interest payments or business expenses from your side hustle. However, if the numbers you report don’t make sense or represent a significant portion of your income, this could potentially raise flags with the IRS.
“Let’s say you had $100,000 of income and you’re taking a $70,000 charitable deduction. Red flag,” Geltrude told CNBC.
It may also raise eyebrows if the deductions you take suddenly look different than usual, Erica James, a certified public accountant, certified financial planner and director at Signify Wealth, told CNBC Make It last year.
“If there are significant changes in the deductions and the credits you’re claiming from year to year, that could potentially raise an audit,” she said. James also said if the deductions you take are valid and well-documented, an audit will likely be a request for additional documentation, and not a larger investigation.
To avoid issues with deductions you take, the solution is simple, James said: “Make sure you have good records.”
3. You have a side hustle or a small business and you don’t keep good records
Small business owners and side hustlers can file a Schedule C form with their tax return to report income from their business activities to the IRS. While owning a business or making extra money on the side is a great way to meet your financial goals, self-reporting businesses are often a target for audits.
“Any business that generates income is subject to scrutiny by the IRS,” says Ed Slott, a certified public accountant and founder of IRAHelp.com.
According to Slott, the best way to help yourself is to keep good records. Not only is having your business documents organized a good way to ensure you enter the most accurate numbers at tax time, but staying organized can also get you on the good side of the IRS if an audit does happen.
Simply keeping all documents related to your business in a separate folder is a great way to start, Slott says. Beyond that, if staying on top of your taxes throughout the year would detract from your ability to run your business, it may be time to bring in an accounting professional to help you sort through your business documents, he says.
“Even if [you] understand QuickBooks and all of that, that’s not what [you] should be spending [your] time on,” Slott says. ”[You] should be spending your time on cultivating business.”
