By Jill Shah
Americans who have put off their 2021 taxes have less than a week to file a return or an extension — and fill them out accurately to avoid trouble from the Internal Revenue Service.
Audits are a risk that all should heed, but especially the lowest-income earners. The IRS looked at their returns at a rate five times greater than all other taxpayers in the 2021 fiscal year, according to data from the Transactional Records Access Clearinghouse at Syracuse University.
The chances of being targeted remain low: Four out of every 1,000 returns filed were audited by the IRS in 2021, and audit rates have been declining over the last decade.
Still, the rise in audits for those earning less than $25,000 has raised alarm bells on Capitol Hill, with congressional Democrats asking the IRS to explain that increase as well as the agency’s reliance on correspondence audits — examinations by mail — to conduct them.
This year, audits may be triggered by changes in eligibility for credits, deductions that have become more common during the pandemic and cryptocurrency activity, according to experts.
Here are major pitfalls to avoid in last-minute tax filings:
It sounds obvious, but filing an accurate return is the best way to avoid an audit, said Jamie Block, a senior wealth adviser at Mercer Advisors. The agency receives information about payments from employers, including 1099 and W-2 forms, and any mismatches could trigger a flag.
Common mistakes include accidentally transposing digits or typing in the wrong line. Depending on the number, that could create a large discrepancy, even for those with modest earnings.
“There isn’t a whole lot of manipulation, for lack of a better word, that a taxpayer can do with those types of incomes, because the IRS already has that information,” said Henry Grzes, lead manager for tax practice and ethics with the American Institute of CPAs.
Tax officials are generally more likely to look into returns with self-employment or rental properties because they don’t necessarily have a record of that income, he said.
For those self-reporting income, using large, round amounts for deductions could trigger a notice, said Anil Melwani, partner at Tanton Grubman CPAs. Self-employed individuals should go line by line totaling income and expenses.
“They’re pretty much thinking that, ‘Oh, this person just threw a bunch of numbers together and probably didn’t actually add stuff up in QuickBooks or Excel, they just estimated it, and the chances of them having proof of that are pretty low,’” he said.
Another red flag is showing little to no income or multiple years of losses in a sole proprietorship. In that case, the agency may wonder if the business is legitimate or should be classified as a hobby without the same write-offs, according to Melwani.
“They don’t necessarily attack it right away,” he said. “But if you show three years of no income or losses in a row, that could do it.”
Exaggerating Home Office, Charity
While more Americans worked from home in 2021, not everyone qualifies for a home-office deduction.
Maintaining a home office has to be for the convenience of your employer and used exclusively for work, Grzes said.
“Using your kitchen table or dining room table isn’t going to meet that test,” he said. “To say, ‘Well, I’m using my kitchen as my home office, and I’ve got seven rooms in my house, and therefore I’m going to take one-seventh of all my expenses and claim that as a deduction on my business,’ that probably won’t work.”
Unreasonable charitable deductions also lead to audit flags, Block said.
While the IRS has increased the limit for claiming charitable deductions from 60% to 100% of an individual’s adjusted gross income, people still need documentation from each charity for donations over $250.
“Under audit, you are required to provide the substantiation,” she said. “If you don’t have them, too bad for you, you lose that deduction.”
Don’t Hide Crypto
Cryptocurrency is front and center on tax returns, with a required question asking taxpayers if they have made any sales or exchanges of virtual currency. Taxable transactions must be reported with capital gains or losses.
“If you answer no, and there’s evidence that you have transactions, then obviously that’s going to be a trigger,” Grzes said. “Even if you answer yes, and you don’t report them, that’s clearly going to be a trigger.”
Many large cryptocurrency transactions are likely to get a closer look, Melwani said.
“We’ll have to see how much they really go after and how they trained their computer programs, because a lot of these returns are being scanned in,” he said. “They don’t have the human resources to go through them on paper.”
Child Tax Credit
Under the 2021 American Rescue Plan, eligible taxpayers received advance payments of up to half of the annual child tax credit. The advance payments were directed based on past tax returns, information entered for stimulus payments or details sent directly to the agency.
On this year’s returns, filers who received advance payments will need to reconcile those with the allowable credit. If circumstances have changed, such as family income, your taxes may be audited and the credit could be reduced.
If you’re not married or are filing separately from a co-parent, only one person can claim the child for a deduction on your tax bill, Melwani said.
“Whoever claims the child is going to get that advantage, but you can’t really share that deduction,” he said. If both parents claim the child, that could also result in an audit.
Earned Income Tax Credit
This year, more workers without children can qualify for the earned income tax credit, which is one of the largest benefits for low-to-moderate income families. It covers workers who are at least 19 years old with earned income below $21,340 (as single filers) and investment income of up to $10,000.
“This really impacted a lot of elderly individuals who may be working part-time, and don’t have a lot of investment income,” said Block, who saw more clients eligible for the credit than in the past.
Wage earners in this category are among the most likely to be audited, the Syracuse data shows. More than half of all correspondence audits last year targeted returns with gross receipts of less than $25,000 claiming an earned income tax credit.
To avoid an audit, ensure both earned income and investment income fall under the limits set by the IRS, Block said.
For those filing extensions: it’s a request for additional time to file a tax return, not more time to pay taxes. Individuals should estimate and pay what’s owed by the deadline of April 18.
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