What to Know
- While having high income raises your chances of an audit, it’s not the only thing that can make the IRS single out your return
Even though the IRS may be just getting back on its feet after the partial government shutdown — with another one potentially in mid-February — don’t assume you can pull a fast one on your tax return this year.
Because much of the agency’s systems are automated to spot certain discrepancies, and some parts of tax returns generate more scrunity than others, the risk — albeit low — of hearing from the taxman still remains.
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And this year, there are more factors at play that could spur attention from the IRS, due to the Tax Cuts and Jobs Act — which taxpayers are now dealing with for the first time as they prepare their 2018 returns.
Most people will never face an audit. Of the nearly 148 million individual tax returns filed in 2016, just under 1 million (about 0.7 percent) were audited, according to the latest available IRS data.
That number does not include other types of IRS inquiries, such as a notice of an income-reporting discrepancy and proposed additional tax due. Those communications fall short of an official audit, which the IRS gets three years to start after the challenged return is filed.
The one item that puts you most at risk for an audit is making a lot of money. If you earn more than $1 million, the audit rate jumps to 5.8 percent, IRS data show.
However, even if your income is lower, don’t assume your tax return won’t generate attention — income isn’t the only consideration.
Here are some things that could cause the IRS to look more closely at your 2018 tax return.
Large charitable donations
While the IRS already has been known to scrutinize tax returns with a large charitable-donation deduction relative to the reported income on the return, there’s a chance those inquiries could rise.
Basically, the tax break for charitable contributions is one of the few deductions remaining. Yet to take it, you must itemize your deductions. And for itemizing to make sense, the total of all your deductions would need to exceed the nearly doubled standard deduction — for example, it’s now $24,000 for married couples, up from $12,700, and $12,000 for singles, up from $6,350.
So, facing a higher hurdle for itemizing, some taxpayers are planning to “bunch” their charitable contributions. That is, you give two years’ worth of charitable donations in one year (and nothing the next year) if it would mean being able to get the deduction.
However, the IRS knows how much taxpayers at various income levels typically donate. So if your charitable-contribution deduction is high relative to your income or in comparison to your income peers, it could trigger interest from the agency.
“That’s definitely a red flag,” said Cari Weston, a CPA and director of tax practice and ethics for the American Institute of CPAs.
Of course, as long as you have the documentation to back up your donations, you shouldn’t fear hearing from the IRS.
And remember the contribution limits: You can give cash donations of up to 60 percent of your adjusted gross income to qualified charities. Other types of donated property also face limits, depending on the type of asset and the organization it’s given to.
The new tax law limits the deduction for state and local taxes — a.k.a., SALT — to $10,000. If this has spurred you to, say, rent a room in your house so you can take advantage of other rules that would reduce your tax bill, be aware that the IRS could be on the lookout for abuse.
“That already was a higher area of audit and it might be higher now,” Weston said.
If you rent out space — whether a whole house or a room — for more than 14 days of the year, you must report the income to the IRS. Yet you also get to reduce the taxable amount of that income by deducting a variety of related expenses.
Costs such as local licensing, fees you pay to online platforms, advertising and marketing are all associated business costs that could be deductible. Other home expenses — repairs, mortgage interest, property taxes, utilities — are deductible on a prorated basis tied to the number of days you rented out the house.
If you rent just a room, the same expenses are deductible, but to a lesser degree. If the room takes up 25 percent of the space in your home, you could deduct 25 percent of expenses allocated to the days it was rented out.
“Some people could decide to rent a room a few times a year but then try to write off substantially more than they’re entitled to,” Weston said.
She said that if you do decide to rent, make sure you have the documentation to substantiate all of your income and expenses.
And while it’s not uncommon for rental activity to generate a loss — i.e., the space could go unrented for a stretch of time — repeated losses also can be a red flag.
“If your rental puts up losses year after year, that’s a red flag to the IRS,” said Bryan Bibbo, an advisor with The JL Smith Group in Avon, Ohio.
There also are other tax rules that affect how much of your rental losses you can deduct in a given year and what other types of income you can use it against to reduce your taxable income.
One of the consistent areas that can cause the IRS to question your return is a discrepancy between your reported income and the information the agency has.
All those forms you receive showing income — i.e., your W-2 from work, a 1099-MISC or 1099-K reporting side income or 1099-INT showing taxable interest of $10 or more on a bank account — also go to the IRS.
And if you fail to report any of those earnings, you’ll hear from the IRS — the discrepancy will generate an automatic letter.
“The No. 1 thing that causes you to get a letter from the IRS is failing to report all your income,” Bibbo said.
Even if you don’t receive an official income form for work you performed, you probably still need to let the IRS know about it: If your income (after expenses) from, say, a side gig is at least $400, you are required to report it and pay taxes on it.
And for the cryptocurrency investors out there, don’t forget you should be reporting your gains (and losses) on bitcoin and its siblings. The IRS has been beefing up its enforcement efforts in that area and cracking down on scofflaws.
“If you think you can get away with not reporting, you should know you’re probably going to get caught,” Bibbo said.
If you own an account in a foreign country, make sure you report it if you are required to — the penalties for willful violation of reporting rules can be steep.
For U.S. citizens living on U.S. soil, if the value of your overseas account’s assets was more than $50,000 ($100,000 for married couples filing jointly) on the last day of the tax year, or more than $75,000 ($150,000 for married couples) at any time during the year, you must report it on Form 8938 as part of your tax return. (The thresholds are higher for U.S. citizens living abroad.)
This is separate from the so-called FBAR (Foreign Bank and Financial Accounts) reporting, which is not filed as part of your tax return. Americans with more than $10,000 held overseas must file an FBAR.
Keep in mind that the IRS might find out about overseas accounts even if you don’t disclose them: Foreign institutions are also required to disclose account holdings by U.S. citizens.
This story first appeared on CNBC.com. More from CNBC: