Most of us like getting attention. It can be fun to bask in the spotlight- but there’s one entity you don’t want paying you extra attention: the IRS.
Tax audits can be nerve-wracking, especially for someone approaching or living in retirement. This demographic is typically very dependent on a smaller income and has less ability to make up financial pitfalls, especially if it means fines or jail time.
1. You Are Self-Employed: Running your own business gives you license to deduct a lot, like your home office, your car, even your utilities. That’s what makes it easy for entrepreneurs to pad their tax bill to get a better refund and/or owe less to the IRS.
But the IRS is aware that business owners can deduct items not related to their business. To ward off the IRS, be as thorough and conservative as possible when it comes to claiming business expenses.
2. You Give a lot of Money to Charity: Charitable contributions are one of the most popular deductions and one of the most common for the IRS to pick up on. Taxpayers who donate used clothes to Goodwill and try to claim that as a $500 deduction — especially if the items have mothballs — will likely get noticed by the IRS.
Keep track of all charitable donations, keeping receipts, if you plan to deduct them. You will need an appraisal for physical items that you want to claim are worth more than $500. (For further reading, see: Tips on Charitable Contributions: Limits and Taxes.)
3. You Didn’t Report All Your Income: While it may be tempting to squirrel away some of your income, be aware that the IRS might already know what you earned. For example, if a company sent you a form 1099, then it means it reported that to the IRS.
Report all your streams of income if you want to avoid an audit. You can face penalties and fines if they find you didn’t report all your income or underpaid your taxes.
4. You Aren’t Taking Required Minimum Distributions: Retirees who are age 70.5 and older may get flagged by the IRS if they have traditional IRAs or 401(k) plans and are not taking their required minimum distributions (RMDs). RMDs are what the IRS requires taxpayers to take every year if they have one of these retirement accounts.
Make sure to take them, as the penalty can be half of what you were required to take. There’s no point in wasting your hard-earned nest egg on fees paid to the federal government. If you aren’t sure how much to take, call the plan's administrator or ask your financial planner. (For more, see: Avoiding Mistakes in RMDs.)
5. You Claimed a Hobby as a Business: The IRS knows that it can take a few years for a business to get off the ground. That’s why it allows you to deduct business expenses even when you’re not making a profit.
Unfortunately, if you do that for too many years, they start to wonder if this is a real business or an expensive hobby. While it may be tempting to deduct expenses from your collectible trains, it may also come up as a red flag for the IRS if you’re not reporting enough income for several years.
6. You Earned More Than $200,000: In general, the more you earn, the more you should pay in taxes. That’s why the IRS will likely pay special attention to those who are earning more — they want to be sure that you’re paying your fair share.
If you report a high income, make sure to keep your receipts and documentation for every deduction and credit. You’ll be guaranteed an easier audit if you are prepared for that outcome.
The Bottom Line
Tax audits can be stressful, and paying extra money for fines — or serving jail time because you made some tax payment mistakes — can be even worse. Be sure you know what the IRS is looking for when combing taxpayers for potential audits. (For further reading, see: How Do IRS Audits Work? and 6 Important Retirement Plan RMD Rules.)