What Triggers an Audit on Income Tax Returns?
Now, while many of the nation’s taxpayers are preparing their annual tax returns, it might be helpful to know that the tax forms you send to the IRS get “scored.” The result of that score will largely determine whether or not you get audited.
The IRS shoots the 114 million tax returns it gets each year through a computer and gives each return what they call a “DIF” score. DIF stands for Discriminate Function, says Nancy McCurley, an IRS spokeswoman. The computer essentially discriminates between usual and unusual expenses and deductions and gives you a higher score when something--or several somethings--are unusual. These unusual items are commonly called “audit triggers.” The lower your DIF, the less likely you are to get audited.
Does that mean you should avoid the triggers? Not necessarily. Experts say you should not forgo legitimate deductions for fear of an audit. But you should be aware that your chances of audit are higher than normal. And that should spur you to keep unusually good records to substantiate the deductions.
What are the audit triggers?
* Unusually high itemized deductions. What’s considered unusually high is secret. But IRS keeps statistics on average deductions. The most recent averages available are from the 1990 tax year, so they’ve probably changed a touch, but they give an indication of what’s expected.
The average medical expense deduction was $4,215 in 1990; the average deduction for state, local and property taxes was $4,432; the average mortgage interest deduction was $7,088, and the average charitable contribution deduction was $1,958, McCurley says.
It’s a bit tricky to translate those 1990 averages into something more useful to 1993 returns, but you can figure that medical and charitable contribution deductions are probably a bit higher. But thanks to declining real estate values and plunging interest rates, average deductions for property taxes and mortgage interest expenses may be lower.
You should realize too that these are national averages and IRS auditors have the savvy to know that there are geographic disparities. People in high-tax, high-price real estate states such as California, New York and Florida, are expected to have higher average tax and mortgage deductions.
* Business travel and entertainment expenses. If you’re claiming miscellaneous itemized deductions that include wining and dining of clients, you can expect some scrutiny. The IRS is sure that a lot of these deductions are fabricated or exaggerated. Keep a record of who you entertained, when, why and what you talked about.
* Casualty losses. Last year was a record one for disasters, so many people may be claiming casualty losses this year. Nonetheless, because they’re unusual, casualty losses are also an audit trigger. Make sure you keep insurance records and appraisals, where necessary, to substantiate your deduction. (If you’re claiming a significant decline in the value of your home because, for example, part of your hillside slid into the ocean, you should get an appraisal from a certified professional.)
* Self-employment income. There’s not much you can do about it, but if you work for yourself, you’re far more likely to get audited than somebody who works for someone else. Your record-keeping requirements are also a bit more complex. You need receipts of deductible business expenses, contemporary records of entertainment and travel costs, records of taxes paid, income earned, etc.
* Home-office deductions. If you write off a portion of your mortgage and utility costs because you work from home, you are very likely to get audited. This deduction, long an audit trigger, is expected to get increased scrutiny this year because the IRS recently won a court case related to home-office deductions. Indeed, the chance of an audit is so good with these deductions that some accountants suggest that you think twice before writing off the expenses.
That’s because home-office deductions are rarely terribly lucrative. You may spend more defending yourself from an audit than you get from the deduction, accountants say. Still, if you work from home because you’re self-employed or because your employer requires you to, and you want to take the deduction, make sure you keep records of meetings held at your home, hours worked and types of activities done there.
Your “most important” jobs must be done from the home location for the deduction to stick. That means it would be difficult for a traveling salesman, who uses the home simply for paperwork, to substantiate the deduction. Free-lance writers who do phone interviews and write from home probably can get the deductions; free-lance photographers, who secure jobs at home but go outside to shoot pictures, probably can’t.
* Mistakes. Caution counts because the IRS has geared up a sophisticated tax “matching” program. If something on your return doesn’t jibe with what they’ve got from your employer, bank or broker, it will kick your return out for further scrutiny. Generally, this doesn’t bring on a full-scale personal audit. It triggers a computerized notice. But if you don’t respond promptly to the computer notice, you may trigger the full-scale audit.
