Retirees, Beware These 7 Tax Audit Red Flags

Retirees, Beware These 7 Tax Audit Red Flags
Photo by Lisa F. Young / Shutterstock.com

Worried about the IRS auditing you? It’s rare, but it does happen.

Of the tax returns filed in calendar year 2016 — and examined in fiscal year 2017 — the IRS audited nearly 1.1 million, or 0.5 percent of the total.

That low percentage might have you feeling relatively confident about the odds that Uncle Sam will come calling.

But don’t breathe a sigh of relief just yet. Certain financial situations can draw extra scrutiny from the federal government.

Following are seven red flags that could trigger an audit. This doesn’t mean you should try to avoid the following scenarios. But it probably behooves you to keep the best documentation you can, just in case trouble comes calling.

1. High earnings — or none

It makes sense the IRS would focus on high earners; that’s where Uncle Sam will find the most buck for his bang on your door. (Actually, the IRS notifies people subject to audit by mail initially.)

In fiscal year 2017, the IRS audited only 0.7 percent of returns filed with an adjusted gross income between $1 and $25,000. Of returns with adjusted gross incomes between $1 million and just under $5 million, the IRS examined 3.5 percent.

It goes up from there. About 14.5 percent of returns with adjusted gross incomes of $10 million or more were audited. And remember, the IRS can audit you for the last three years. If they find a “substantial error,” they can then go back and audit returns even further back in your tax history.

The IRS also scrutinizes people with an adjusted gross income of $0 more often than most other tax brackets. A relatively large 2.6 percent of this group was investigated in fiscal year 2017.

2. Failing to report income (or misreporting income)

Don’t overlook any source of income when filing your taxes. If you get a tax form — whether it’s a W-2, a 1099 or something else — the people who paid you sent that information to the IRS, too.

If that income doesn’t show up on your return, or is listed in the wrong amount, the IRS might automatically flag your return. The agency probably will wonder what other oversights you made.

3. High deductions

The IRS is transparent about how it picks people to audit. The agency chooses some people at random. In other cases, you might be chosen because you worked with others — such as business partners or investors — who are being audited. And some audits come from an algorithm that compares your return with everybody else’s:

Sometimes returns are selected based solely on a statistical formula. We compare your tax return against “norms” for similar returns. We develop these “norms” from audits of a statistically valid random sample of returns.

In other words, Uncle Sam knows lots of people like you, and he knows what kinds of deductions they tend to take.

Anything unusual about your return — even if it’s completely legitimate — will stick out like a sore thumb. That includes abnormal deductions for charity, medical expenses and business expenses.

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