The IRS typically narrows in on filers with huge deductions relative to their income, business filers with extra or suspicious write-offs, those claiming earned income tax credit or anything unusual. While investing is not the most common trigger for an audit, it still happens. (Flower Mound Tax CPA: Don’t Let Your Investments Trigger an Audit)
One of the easiest ways to avoid a dust-up with the IRS is to report all your income accurately, since the IRS automates this part of the process and flags discrepancies.
IRS audits typically follow the money. Audits are more likely for higher-income individuals, as the potential to yield larger tax adjustments lays with that demographic.
Of course, that’s not a license for low-income filers to fudge their returns. Because returns are managed electronically, the IRS can quickly detect if something looks unusual.
Investors need to be on the lookout for discrepancies in the following areas:
1. Real estate deductions
If you’ve invested in real estate and you manage it yourself, you’ll be writing off legitimate expenses related to the rental property – such as repairs, depreciation and advertising expenses. However, problems arise when property owners get aggressive, writing off too much for the property or claiming deductions that they shouldn’t be able to deduct.
Given the low interest rate environment, it would cause scrutiny if there are large irregular mortgage deductions. While the IRS gives landlords some latitude in claiming deductions, it’s not carte blanche. Real estate investors will need to substantiate deductions if the IRS knocks on their door.
2. Missing dividends and interest
Forget to include all of the dividends and interest from your banks and brokerages? That might make the IRS curious, especially if the amount is material. But even if you have made an error, you might not need to sweat.
The IRS may simply correct the deficiency and deduct the extra from the return you filed. Or, if the tax exceeds your refund check, you’ll be asked to cough up more money.
But the IRS may not look so kindly on a much larger 1099 that goes missing. The unreported income could possibly trigger a further in-depth audit.
3. Missing capital gains
If you sell a stock or other security and you’ve earned a profit on it, congratulations – but you now have a capital gain. You will likely owe tax on that gain. The rate depends on whether you held the security for more than a year or not.
Taxpayers ordinarily note a capital gain on Schedule D of their return, which is the form for reporting gains on losses on securities. If you fail to report the gain, the IRS will become immediately suspicious. While the IRS may simply identify and correct a small loss and ding you for the difference, a larger missing capital gain could set off the alarms.
While your brokerage will send you a tax form that records your gains and losses, you’re on the hook for properly reporting them to the IRS. And it’s easy to forget to report them for accounts that you check infrequently.
Finally, don’t assume that you can skip reporting a capital gain because the broker’s year-end tax report was delivered late. If you file your taxes too early and don’t report the gain, you’ll have to file an amended return and explain to the IRS what happened.
4. Misfiled employer stock options
The tax issues surrounding employer stock options can be tricky, to say the least. In many cases, employees are reporting little to no gains on them, so they may think they don’t need to report it. In fact, it’s common for the taxpayer to not report the sale, but that’s a big no-no.
Here’s what often happens: an employee may be granted options as a perk. When employees want to exercise those options, they put up the money and buy the stock at the agreed-upon price. Many times, employees will simply turn around and sell the stock. However, they often fail to report the exercise price of the options, which is the correct cost basis for figuring the taxable gain.
This common options strategy still requires reporting of a sale on a tax return even though there is little to no gain or loss. Although this is a fixable problem by ultimately reporting the correct cost basis, the IRS may initially assume that all of the sale proceeds are short-term gains even though they may not actually be taxable at all.
If you don’t report the cost basis, the IRS just assumes that the basis is $0 and so the stock’s sale proceeds are fully taxable, maybe even at a higher short-term rate. The IRS may think you owe thousands or even tens of thousands more in taxes and wonder why you haven’t paid up.
5. Filing late
The IRS wants to be paid, and it wants to be paid on time. That can be difficult for investors sometimes, especially when investments are especially complicated or year-end statements may arrive very late. In fact, some companies report tax information into April or even beyond the April 15th tax deadline.
While an investor’s tax returns may be more complicated than the average return, the IRS still wants a timely filing. And by obliging them, you’ll stay off their radar and attract less attention.
Any deduction or new source of income creates another potential point of interest for the IRS. So in addition to the usual sources of concern such as common deductions and missing income, investors should also concern themselves with conscientiously noting income from their stocks, bonds and real estate, among other kinds of investments. But like all taxpayers, they’ll also want to do the little things that keep the IRS from knocking.
Call Williams & Kunkel CPA today in Flower Mound at 972-446-1040 to have a chat and find out how you can save money on your taxes as a real estate professional.