Now that tax season is over, audit season has arrived. Based on statistics released in the 2017 IRS Data Book, the audit rate for individual tax returns is the lowest it’s been since 2002. It’s currently 0.6 percent, or about one in every 160 returns. That rate amounted to 934,000 audited returns in 2017. While the audit rate is decreasing, it’s still important to educate your clients on the things that commonly trigger an audit.
Here are five common reasons your clients may have been audited. With your guidance, you can help make sure your clients understand the reasons and the best courses of action going forward.
Common reasons for being audited
There are many factors that go into an audit selection, but generally speaking, here are some of the top reasons your clients may have been audited:
They claimed a disproportionate charitable contribution deduction. Each year, millions of taxpayers claim the charitable contribution deduction. Even under the new tax law, many taxpayers will still be able to claim the deduction. However, your clients will run into trouble if they claimed an amount for the deduction that was too high compared to their income. The IRS has charitable deduction amounts that it deems proportionate for each income level.
They are self-employed. Your clients who are self-employed are more likely to be selected for an audit than your clients who are not self-employed. This is because Schedule C includes so many potential deductions business owners can claim.
For example, if your clients claimed excessive deductions for things like business meals, travel, entertainment, vehicles, or showing a significant net loss, the IRS will more closely scrutinize their returns. Be sure to make your clients aware of the importance of having receipts and detailed records for all business expenses they deducted.
They claimed the home office deduction. The home office deduction is for those who use a space in their home “exclusively and regularly for their trade or business.” The IRS is great at finding taxpayers who claimed the deduction fraudulently. It will be difficult for your clients to prove they really did qualify for the home office deduction.
They wrote off a loss for a hobby. Your clients should have reported income for a hobby and may have qualified for some deductions, but they should not have written off a loss from a hobby. The only reason they would have been able to write off a loss is if their hobby was run like a business and they had an expectation of profit.
They have a foreign bank account. If your clients have bank accounts outside of the U.S., they should have kept detailed records and reported it on their tax return accordingly. The IRS keeps a close eye on taxpayers who have foreign accounts, especially if it’s in a “tax haven” country. If you can, it’s best to consult clients on the implications of having a foreign bank account before they ever open one.
There are, of course, other reasons your clients may have been audited that are out of your control—if they made a lot of money, if they failed to tell you about sources of income, etc.—but by being proactive and educating your clients about the auditing process, you’ll help minimize the red flags they put up to the IRS in the future.
What you can do as a tax professional
Aside from educating your clients about the reasons for audit, you can also take a few actions yourself to decrease the chance of your clients getting audited next year:
- Double check your math. You should always double check the numbers you’ve entered on your clients’ tax returns. If the IRS finds a math error, it may request additional documentation from your client.
- Round to the nearest dollar. Chances are, the numbers and estimations on your client’s return will not all be nice numbers that end in zero. If you have to estimate an amount, round it to the nearest dollar rather than the nearest interval of 10. If the IRS finds too many round numbers, it may become suspicious and ask for additional documentation.
- Review returns for errors. In addition to checking for math errors, you should review your client’s return for other errors as well. Items like a missing signature or a mistyped Social Security number are easy to overlook, but they’re a sure way to get your client selected for an audit.