1. Failure to report all taxable income. The IRS receives copies of all 1099s and W-2s and computers match these forms with the income shown on the return. A mismatch is a red flag!.
2. Returns claiming the home-buyer credit. First-time homebuyers and longtime homeowners who claimed the homebuyer credit should be prepared for IRS scrutiny. Submit proper documentation; first-time homebuyers should attach a copy of their settlement statement and longtime homeowners should attach documents showing prior ownership, for example records of property tax and insurance coverage. All claims for this credit are being screened. Remember, the credit is required to be recaptured if the home is sold within three years for homes bought in 2009 or 2010 and within 15 years for homes bought before 2009.
3. Claiming large charitable deductions. Charitable deductions that are disproportionately large compared to reported income, raise a red flag. Reminders: Get an appraisal for donations of valuable property and file Form 8283 for donations over $500.
4. Home office deduction. History has shown that many people who claim a home office don’t meet all the requirements and others may overstate the benefit. In order to take this write-off, the space must be used exclusively and on a regular basis as your principal place of business.
5. Business meals, travel and entertainment. Schedule C filers should be careful when claiming large deductions for meals, travel and entertainment. To qualify for meals or entertainment deductions, detailed records must be kept including the amount, place, persons attending, business purpose and nature of discussion or meeting. Also, receipts are required for expenditures over $75 or any expense for lodging while traveling away from home.
6. Claiming 100% business use of vehicle. It is extremely rare that an individual actually uses a vehicle 100% of the time for business, especially if no other vehicle is available for personal use. Keep detailed mileage logs! Also, be sure not to include actual auto expenses when using the standard mileage rates.
7. Claiming a loss for a hobby activity. It’s a red flag if a Schedule C loss-generating activity sounds like a hobby (horse breeding, car racing). The activity should be run in a business-like manner and for a profit!
8. Cash businesses. Cash-intensive businesses, for example taxi drivers, car washes, bars, hair salons, and restaurants, are targets since they are less likely to accurately report all of their taxable income.
9. Failure to report a foreign bank account. The IRS is intensely interested in people with offshore accounts, especially those in tax havens. Failure to report a foreign bank account can lead to severe penalties. Proper reporting is crucial!
10. Engaging in currency transactions. The IRS receives reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious activity reports from banks and disclosures of foreign accounts. Those making large cash purchases or deposits should be prepared for IRS scrutiny.
11. Math errors. One of the most common reasons for an IRS notice is the simple mathematical mistake on the tax return. Take time to ensure all your calculations are correct to remain under the radar!
12. Taking higher-than-average deductions. Deductions disproportionately large compared to income is a common red flag. Be sure to have proper documentation!