Top 10 red flags which show the danger of tax audit

The work of preparing and filing your tax return is relatively easier than defending your return in the event of tax audit.  Around 1.5 million taxpayers face tax audit every year.  There is no proven formula to avoid tax audit but you can look out for red flags.

Here are top 10 red flags which may trigger tax audit –

1. Unreasonable deductions for home office – If you operate your business from home, you are tempted to deduct most of your spending as business expenditure.  There are specific rules published by IRS to classify business and personal expenditure.  If you miss out on some of them, you are inviting a tax audit.
2. Mismatching your Federal and state tax returns – If there is a difference between the incomes declared on these two tax returns, it will be immediately picked up by IRS computers and you will soon get a notice for tax audit.
3. High earnings – If your annual income crosses $100,000, it may attract the attention of IRS.
4. Excessive charitable contributions – If your contributions to charity range between 5 to 10 percent of your income, IRS feel it is a good reason to ask you explanation.
5. Mess up in alternative minimum tax (AMT) – If you are subject to AMT, you should approach a tax professional in order to avoid calculation mistakes.  Even if you feel to submit AMT schedule, you become prominent to attract attention of IRS.
6. Incorrect reporting of dividend and interest – Some people tend to ignore small amounts of dividend while preparing their tax return.  Some people are careless about keeping a record of all the dividends they receive during a year. It is very easy for IRS to cross-verify such interest and dividend figures as their computers are programmed accordingly.  Even a single omission of dividend or interest item will immediately alert IRS.
7. Assigning your tax work to an unprofessional consultant – Some of the so-called ‘professional’ tax consultants will promise you a refund without checking all your papers.  In the process there may claim for some inflated or the illegal deductions which will attract the attention of IRS.  The consequences of such a mess are too serious – including heavy interest and penalties.
8. The habit of rounding it up – If you have received a dividend of $609.49, you cannot round it up to $600.  There are many numbers on your tax return which will not be round numbers.  If your return is full of such numbers, it may become ‘eligible’ for tax audit.
9. Erratic changes in your income – If your income for the last year was $100,000 and for the current year you declare an income of only $20,000, IRS will be suspicious about your return and would like to investigate it more.
10. Claiming too many tax credits – While claiming credits for education, earned income or for seniors, people tend to confuse.  It is a human tendency to claim more than what you are entitled for.  Naturally, you pay lesser taxes then required.  Finally, the hassle of clearing this mess can be much more than the value of that wrongly claimed credit.

If you are a disciplined to keep proper records and claim only legitimate deductions, most of these red flags should not concern you. If you are confused about a particular item, it is advisable to take advice of a tax consultant.