Watch Out for These 5 Red Flags in Your Tax Return
The IRS may take a closer look at these items on your return. Here's how to avoid sending up a red flag.
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Even with the availability of online tax software, filing your taxes can still be nerve-racking. No one wants to trigger an IRS audit, but with so many complicated questions and detailed responses required, it can seem easy to get something wrong.
Here are five things you should watch out for so your tax return doesn't raise a red flag to the IRS.
1. Unreported income
Unreported income is a big red flag on your tax return, and it's easy for the IRS to spot it. For example, if you're a freelancer and were paid $600 or more for your work, those businesses must file their own paperwork showing they paid you. And because they file forms saying they paid you, it means the IRS knows whether or not you're correctly reporting your income on your taxes.
If you're not a freelancer, the IRS still receives tax forms from your employer, so make sure you report the same income that's listed on the forms you receive from your employer. It's worth mentioning that if you received income from your brokerage account, you need to report that, too.
How to avoid the red flag: Report all of your income! As a freelancer, I know this can be difficult to track, especially if you have many clients. Double-check your client lists, look at bank statements for payment amounts, and follow up to ensure you've received forms if you're supposed to receive them. These may include a W-2 for employees and 1099 forms for freelance work and brokerage income.
2. Misreporting business expenses
The IRS keeps a close eye on business expenses that don't quite add up. If you have legitimate business expenses like traveling or meals, it's important that you report these accurately and don't confuse business expenses with personal ones.
TurboTax says the IRS will scrutinize excessive business tax deductions. One way it does this is to look at the typical travel and business expenses for specific occupations and compare them to your deductions.
How to avoid the red flag: Keep receipts of your business expenses and make sure that purchases are clearly business costs. If you're unsure about your business expense claims, you can check them against the IRS' business expense resource.
3. Digital asset transactions
The IRS is getting more serious about tracking digital asset transactions. On 1040 forms, the agency asks about any potential digital asset income from the past year, including cryptocurrencies, stablecoins, and non-fungible tokens (NFTs).
Everyone has to answer the question of whether they've engaged with digital assets or not. And if you respond in the affirmative, the IRS says, "...taxpayers must report all income related to their digital asset transactions." The IRS says that you may not need to report if you simply owned digital assets but didn't engage in any transactions with digital assets during the year.
How to avoid the red flag: First, everyone must answer the question on their tax form, regardless of whether you did anything with digital assets during the year. Make sure to check "yes" if you received a digital asset, transferred one, disposed of, or sold digital assets. Then, file the correct forms to show your digital asset transactions. Check out the IRS's detailed information on digital assets.
4. Using round numbers
If you're listing business expenses, you should list specific amounts and not round numbers. For example, if you list advertising expenses of $500 for the year or office supply costs of $100, this will likely send up a red flag to the IRS.
If some of your expenses are legitimately round numbers, that's okay, but the IRS says on its website that it's "unlikely" that all businesses' expenses are round numbers. If you list your expenses in round numbers, the IRS will assume you're just estimating.
How to avoid the red flag: Keep specific records of your expenses to list the accurate amount when claiming deductions. Using expense management software makes it easy to search for expenses by category to give the IRS specific numbers.
5. Large charitable deductions
Making significant donations to charity may not be a red flag in and of itself, but it might be if your donations are disproportionate to your income.
The IRS knows the average amount people give to charity in your income bracket, and if your donations are much higher than that, it may give your tax filing a closer look. And if you list non-cash donations above $500, make sure you file Form 8283.
How to avoid the red flag: Like everything else on your tax return, make sure you're being as specific as possible and have the paperwork to back it up. Using a budgeting app to keep track of your donations might be helpful in this situation. You should get appraisals for non-cash donations. You can find out more about that process on the IRS website.
Filing your taxes can be stressful, especially if you're worried about triggering an IRS audit. The good news is that even free tax software can help you file your taxes correctly.
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