by Alex Franch, Tax Specialist
In 2012, Americans filed 145 million individual income tax returns. 1.4 million of those returns will receive some level of examination from the IRS. Here are a few ways to draw additional scrutiny from the IRS.
Making Too Much Money
Why, because that is where the money is. If you make over $1M, your likelihood of being examined jumps to 10.8%. Since any changes to your tax return are most likely to affect income being taxed at the highest marginal tax rate of 39.6%, there is a strong incentive to look a little closer.
Interestingly, those small business owners making over $200k are slightly less likely to be examined than those making between $100k & $200k. My hypothesis is that the Alternative Minimum Tax wipes out a number of deductions that would make an examination moot and the payroll tax is already maxed out leading to diminishing returns for the additional efforts of the IRS.
Taking Large Charitable Deductions
I have done many returns for people who tithe, and while this may draw additional scrutiny, it has been my experience that many taxpayers who tithe tend to have a pretty decent record and the majority of the gifts go to one particular place of worship.
For everyone else, (1) make sure you have proper documentation, (2) make sure you have proper documentation, and (3) make sure you have proper documentation.
Claiming Day-Trading Losses on Schedule C
Do you remember Sesame Street: Which one of these is not like the others? It is claiming day-trading losses on a Schedule C!
Normally capital losses are limited to ($3,000) per year but not if they qualify to be on a Schedule C. The key here is that you have to qualify or otherwise be eligible to do so. I guess this is too tempting for too many people that the IRS will give this additional scrutiny.
Estate Tax returns actually have an 11.6% examination rate, double if you go over the $5M Estate tax threshold. I have a hypothesis about this based on my experience in dealing with the next of kin. They had no idea what mom & dad had in their names and the resulting return leaves them exposed to additional scrutiny. Example: “Dad had a timeshare in Florida? Well I guess I forgot to mention it on the return. Oops, my bad.”
Using the Wrong Status
Divorce can be stressful enough without having to juggle the correct filing status at the corner of Federal and State law.
IRS code dictates filing status regardless of who is claiming a dependent. IRS code also dictates who is entitled to claim a dependent but this can be overruled by your local probate court.
Let’s say mom & dad both claim junior and/or Head of Household. In comes the IRS to sort it out for you. The worst part of these types of examinations is that the documentation you are seeking is not always cut & dry so it can be a frustrating ordeal.