The tax deadline this year is April 17, 2018. Filing your taxes can be complicated, but simple mistakes can lead to an audit by the Internal Revenue Service. The IRS may randomly select a taxpayer’s return and compare the return to other similar returns to check for anything out of the ordinary. Other ways taxpayers are selected for audit is that they are linked to a family member or business partner who is already being audited.
The IRS can audit returns for up to three years old. If there is incorrect reporting information found, the penalty charges could be 20% of the disallowed amounts for filing an “erroneous claim for a refund or credit” or $5,000 if the tax return was deemed “frivolous” where there isn’t enough information to assess whether the information is correct or not. In more serious cases, the taxpayer could be brought to trial to face criminal charges for tax evasion or fraud.
Common Red Flags
Do you really operate a business? Many times, in reviewing returns, I see business losses claimed by a taxpayer. If you claim business expenses, be prepared to prove the expenses claimed. The rules will change as to business expenses next year but for this year employers can deduct more than 2% of their adjusted gross income for unreimbursed employee expenses. A sudden avalanche of business expenses will create a red flag to the IRS. You should keep detailed records of expenses by using a credit card which shows each expense or an expense report outlining in detail the list of expenses.
Withdrawing from a retirement account early
An individual can take withdrawals from a retirement account before he is 59 ½ years old. Usually it is to buy his first home, qualified educational expenses or emergency medical costs. The IRS charges a 10% penalty on top of the tax paid on the withdrawal if the exceptions to withdraw are not met. What happens is that the taxpayer does not report the withdrawal when they did not qualify for the exception. However, the withdrawal is reported to the IRS by the retirement account provider. The taxpayer will then be notified by the IRS that the reported income did not include the early withdrawal amount.
Claiming a loss from a hobby
Wouldn’t it be nice to deduct the expenses for my daughter’s beloved pony? However, a hobby is not a business. The IRS allows a hobby deduction for expenses up to the amount of income generated by that hobby.
If a taxpayer is taking a higher than average deduction in relation to his income, this will become a red flag to the IRS. If you are generous, be prepared to prove it by having receipts to provide to the IRS.