IRS selects returns for audit based on numerous criteria. Here are some common ways your return can be selected for an audit:
- You fail to report income that reported on a W2 or 1099 (this can be from a sale of real estate, 1099-S; non-employee compensation as an IC; 1099-MISC now a 1099-NEC (non-employee comp); or withdrawing proceeds from a retirement account, 1099-R)
- You fail to report all of the income received by your business. For instance, if your company receives credit card payments, your merchant provider will send you a 1099-K every year. The 1099-K will summarize the gross proceeds you received each month and the total for the year. If the gross proceeds you report on your return are less than the 1099-K income, this may indicate you are underreporting your income. There are many legitimate explanations for why your gross income is less than the amount on your 1099-K. But how you report and explain the difference in your tax return can make a difference between being selected and not being selected for an audit.
- You amend your income tax return to claim a refund.
- If you have a business, reporting a loss for more than 1 year can trigger an audit especially if the loss will offset other income reported on your tax return.
- Having a business that is really a hobby such as placing a yacht or aircraft in a business entity and reporting a loss. The question here is whether this is a business or a hobby. A business will have an intent to make a profit and you will be expected to establish you are attempting to get clients and have necessary and ordinary business expenses.
Other ways: IRS has an algorithm and assigns a score to your return. Based on that score, IRS may select your return for examination and send your file to an IRS office in your local city.
If you receive a letter from IRS confirming your return has been selected for examination, contact a qualified tax attorney to review your return and identify the items that will likely be investigated so you can be prepared before communicating with IRS. Having a game plan is critical. You want to be honest but prepared when speaking with IRS.
John D. Milikowsky
Founder of Milikowsky Tax Law
We keep businesses in business.