Franklin D. Roosevelt famously said, “The only thing we have to fear is fear itself.”
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The IRS examines returns to ensure that income, expenses, deductions and credits are reported accurately. When an inconsistency is found, a taxpayer may undergo an audit or be notified that adjustments were made that could result in a refund or a required tax payment.
In fiscal 2022, the IRS closed 708,309 audits, resulting in nearly $30.2 billion in additional taxes assessed.
Here are five common ways to trigger an audit or a frightening notice from the IRS.
Math errors
The IRS’s automated process catches millions of math errors on tax returns each year. In fiscal year 2022, the agency issued close to 16 million math error notices.
The top math error involved the recovery rebate credit, the pandemic-related Economic Impact Payment under the $1.9 trillion American Rescue Plan. The second most found error was for the child tax credit.
A math error might not result in an audit. However, if your return is selected for a manual review, other issues may arise that trigger an audit.
Failing to report all your income
The agency’s “automated underreporter” program could generate a letter if it appears you haven’t reported all income. The IRS compares returns with documents it receives, such as W-2s or 1099s from employers or financial institutions; if the information doesn’t match you’ll likely get a CP2000 notice.
A discrepancy could result in additional taxes owed or possibly a refund.
In fiscal 2022, the IRS closed nearly 1.6 million cases under the automated underreporter program, resulting in more than $8.7 billion in additional tax assessments.
For the average taxpayer, you’re more likely to get one of these letters or a math error notice, rather than an audit, said IRS spokesman Eric Smith.
“Fortunately, these notices can often be avoided by filing electronically and taking a little care upfront,” he said.
My husband and I once got a notice as part of the underreporter program. It claimed the IRS had received a 1099 showing $25,000 in income we hadn’t disclosed on our joint return and said we owed $12,255 in back taxes, including interest and penalties.
After hyperventilating, I calmed down enough to do some reporting and found the source of the error. A media company that I had done some television work for had a glitch in its internal accounting system and, as a result, it incorrectly generated a 1099 under my name and Social Security number that was meant for a famous music artist. (And, no, I’m not at liberty to disclose her name, but she’s a member of the Rock and Roll Hall of Fame.)
The company issued a corrected 1099, and the matter was cleared up after about two months.
“If you do get a letter, please open it right away and reply promptly,” Smith said. “We’re now making that easier too.”
Now, you often reply by scanning a QR code or uploading needed documents using an online Document Upload Tool at irs.gov.
Don’t be afraid to contact the agency for help. In fact, the IRS will open 70 Taxpayer Assistance Centers on March 16, from 9 a.m. to 4 p.m. to provide in-person assistance. Special Saturday openings are also planned for April 13 and May 18.
By the way, substantially understating your income could result in a severe penalty. The IRS has the authority to hit filers with an accuracy-related penalty equal to 20 percent of their underpayment of taxes.
Out-of-the-ordinary deductions
Wondering why your return is selected for review?
“Sometimes returns are selected based solely on a statistical formula,” the IRS says. “We compare your tax return against ‘norms’ for similar returns.”
If the deduction is allowed, take it. However, deductions that appear out of line with your income can be a red flag. For instance, if you declare $40,000 in income but also claim $10,000 in charitable contributions, the IRS may investigate your extraordinary generosity.
Overstating business deductions
I’ve attended numerous entrepreneurial seminars at which a so-called expert overstates what people could claim as a business expense.
“A common misconception is that you can write off the full cost of a vacation by just conducting a minor piece of business, or deduct the full cost of a car with only rare or occasional business use,” Smith said. “Neither of these is true.”
“To be deductible, a business expense must be both ordinary and necessary,” according to IRS Publication 583 (Starting a Business and Keeping Records). “An ordinary expense is one that is common and accepted in your field of business, trade, or profession. A necessary expense is one that is helpful and appropriate for your business, trade, or profession.”
A pattern of losses for your small business
If you own a business, consult a tax professional and also read IRS Publication 334 (Tax Guide for Small Business).
You may run into an issue if the IRS questions whether you have a profit-making business or enterprise is more like a hobby.
“If you do not carry on your business to make a profit, there is a limit on the deductions you can take,” the agency says in the publication. “You cannot use a loss from the activity to offset other income.”
