Internal Revenue Service red flags lurk around every corner, so don’t get caught red-handed by leaving them in your return.
Unfortunately, Internal Revenue Service red flags are more common than you might think – and they might get you in trouble. If you want your returns to stay un-audited (and don’t we all?), it’s best to avoid them.
Of course, that first means identifying them. Here are five of the most common red flags that crop up and how to steer clear.
#1: Business Loss Write-Offs
Writing off business losses is a natural way to reduce your taxable income, especially in the early years of a startup. When it’s legitimate, it is a helpful deduction that keeps you afloat during tough times.
However, if you take a loss on your business that reduces other taxable income on the return, or claim a loss more than three years in a row, the IRS is going to look at it very carefully. Businesses are in the business of making money. If you consistently fail to, they will likely reclassify your business as a hobby or audit you in general for not showing a profit.
#2: Alimony Deductions
Alimony deductions are a common red flag. Though alimony is different from child support, many taxpayers unintentionally conflate the two. That’s a problem because while you can write off child support, you cannot write off alimony.
Before you write off any expense related to divorce or separation, check the divorce decree and alimony rules carefully.
#3: Unreimbursed Employee Business Expense
Business owners are free to take deductions, but employees are not. Their only option is to deduct unreimbursed employee expenses. You may claim business-related expenses beyond 2% of your adjusted gross income. However, many employees get in trouble by claiming expenses that don’t actually relate to business, such as:
- Meals and entertainment
The IRS is wary of those expenses, and may well look into them carefully to ensure they’re truly necessary for your work. Note that as of 2018, these will no longer exist so that it will become a non-issue. However, if you’re dealing with back years, this still very much matters.
#4: Dependents with Different Last Names
A lot of people will falsely claim dependents to get tax credits. For instance, a mother of one might claim the child of a friend who has six kids and split the extra refund amount. That’s not you, obviously, but it is why the IRS uses this as a red flag. If you’re going to claim a dependent with a different last name, make sure they really “belong” to you.
#5: High Withholdings
High federal withholdings also raise IRS hackles. Typically, federal withholdings range between 10 and 20 percent. If you claim 30-40 percent withheld, the IRS will think you’re artificially inflating the amount earned to fraudulently increase the refund. Don’t do that. Stick to the normal range. Ask your tax preparer if you really don’t think that represents your situation.
If you’re ready for a return that’s free of Internal Revenue Service red flags and gets you the biggest possible refund, it’s time for help. Get in touch with us here at Incompass Tax, Estate, and Business Solutions, and we’ll help you do just that.