IRS Audit Red Flags – Part 1: Individual

It is time to prepare your 2016 income tax return, account for your income, and pay up. It would be nice if it were that simple, but it isn’t. Filing your return and paying the amount of tax due may not be the end of it. To keep taxpayers honest, the Internal Revenue Service (IRS) pulls a small percentage (less than 1%) of returns for audit.

Even if you are completely honest and forthcoming about income and deductions when you file your tax return, you do not want to be audited if you can help it; audits take your time, can cost you money if you need to hire representation, and are stressful.

According to the Internal Revenue Service, returns are not selected for audit at random; something about the return triggers an audit. Try to avoid the following audit red flags when filing your return.

Rounded numbers: When the numbers you enter end in zeros, the IRS suspects you are not using actual figures. Occasionally, you make have an actual number that ends in zeros. One such number will not likely flag your return, but a lot of rounded numbers will.

Unreported income: Any income you fail to report that has been reported to the Internal Revenue Service by a third party (1099 and W-2 income) automatically flags your return.

Sloppy or incomplete information: A tax return with math errors or that is incomplete will trigger a red flag. The IRS advises the use of tax preparation software to avoid this red flag.

Charitable donations: This deduction is often abused, so if you claim charitable donations in excess of the average for your income bracket, your return will be flagged.

Earnings of $100,000 or more: People with high incomes make it easy for the Internal Revenue Service to justify the expense of an audit. Consequently, those with incomes over $100,000 are 500 times more likely to be audited than those who earn less than that amount. You cannot avoid this red flag if you make over $100,000, so be sure to obtain and retain good documentation for any deductions or credits you claim.

Low income for your profession: The IRS has data on the average income in your locale for people in your particular profession. If you report income significantly lower than what the IRS would expect for someone in your profession, your return may be flagged to verify income.

Differences in Federal and State tax returns: When information on your Federal income tax return does not match the information you report on your State income tax return, red flags are triggered at both the Internal Revenue Service and your state revenue department. The IRS recommends using tax preparation software for your Federal and State returns to avoid this red flag.

Large swings in income: The Internal Revenue Service likes consistency. Consequently, large swings in income that cannot be explained by W-2 or 1099 reporting will cause your tax return to be flagged.

  • Job expenses: If you are a W-2 employee and take a job expense deduction, your return will be flagged. The IRS knows from experience that many more people take this deduction than can legitimately do so. They will assume that you may be one of those people.
  • Tax avoidance transactions: If the Internal Revenue Service discovers you have participated in tax avoidance transactions or if they suspect that you have, your return will be flagged for an audit.

    There is no way to absolutely avoid an audit of your federal income tax return. Nevertheless, the odds are in your favor that you will not be audited. You can improve those odds by avoiding audit red flags where you can and using tax preparation software to complete your return.

    Part 2 of IRS Audit Red Flags will address business returns.

    K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages

    All Debt Becomes a Drag on the Economy, Not Just Student Loans

    For the last couple of years, there has been a great hue and cry from economists, politicians, and certain special interest groups over the size of outstanding student loan debt and how it is a drag on the economy. At $1.2 trillion, student loan debt is second in size to mortgage debt. Although, outstanding credit card debt is close behind at $1 trillion. But I don’t hear anyone bemoaning mortgage or credit card debt as a drag on the economy. Why is student loan debt singled out as an impediment to economic growth?

    How debt repayment affects the economy

    It does not make sense because all debt becomes a drag on the economy once repayment begins. Initially, the use of credit is a boost to the economy. When credit is utilized, money that has not yet been earned is spent and purchases that would have occurred in the future are brought forward into the present. This gives the economy an artificial boost. But once repayment of debt begins, the money used for loan payments does not add to current economic growth because it is paying for past purchases.

    Student loan repayment is no worse than any other type of debt

    Student loan debt operates in the same way. When the borrowed money is spent, it boosts the economy: instructors and other employees at universities, trade schools, technical schools, and so forth get paid; textbooks, computers and other technology, supplies of all types, furnishings for dormitories, classrooms, and laboratories are purchased; maintenance services of all types are contracted; money is spent on transportation, printing, and advertising. All of which grows the economy. Then loan repayment begins and that money is no longer available for current spending.

    Economists and policymakers want to have their cake and eat it too

    Economists and policymakers want it both ways; they want to bring purchasing forward by expanding credit and still have economic growth when debt repayment begins. The only way to accomplish that is if there is a sufficient increase in incomes to offset loan payments or if additional credit is extended to those already in debt so they can continue to bring future purchases forward. The former has not occurred due to wage stagnation, and the latter is similar to a Ponzi scheme; eventually the chickens come home to roost when consumers become saturated with debt and credit can no longer be expanded, loan payments gobble up disposable income, and economic growth tanks.

    The fact that the Federal Reserve kept interest rates at near zero for over seven years during the recent economic recovery indicates that the expansion of consumer credit as a means to grow the economy may no longer be a viable strategy. Loan repayment of all kinds could be a drag on the economy for a very long time unless wage stagnation is overcome.

    K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages

    You Must Be the Agent of Change

    When it comes to personal saving, it is often assumed by the news media, economists, and policymakers that those who are not saving at all or saving very little have no choice. They are stuck, and something external to their personal finances must change in order for non-savers and those who under save to be able to increase their level of saving. Most often this external something is an increase in income; with more income, non-savers and those who under save will increase their rate of saving.

    External changes alone do not produce an increase in saving

    Do not accept this faulty logic. An external change in circumstances will not produce an increase in the savings rate unless the person has already changed her spending habits. Absent a prior change in money management, any increase in income will be spent. Most probably it will be leveraged to make a credit purchase. The increase in income will be used to make the payment on the new debt. Lottery winners, big and small, prove this point all of the time.

    You must be the agent of change

    If you hope to increase your rate of saving, reduce your debt, or achieve any other personal financial goal, you must be the agent of change. When you change your attitude about money and how you manage it, your finances will improve. You do not have to wait for external circumstances to change; it is all in your hands. Start where you are right now and make some small changes in the way you spend money; when external circumstances improve, you will be able to take full advantage of them.

    Here are links to some earlier posts that will help you:

    How to Create a Budget, Part 1

    How to Create a Budget, Part 2

    How to Create a Budget, Part 3

    Emergency Fund

    Financial Priorities

    The Four Types of Saving

    Debt Repayment

    K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages