Does the IRS really review every tax return?

Most tax returns are received and processed by the IRS without further examination. However, there are a variety of factors that may attract the attention of the IRS in a way that would make the return more likely to be audited through a correspondence exam or assigned to an auditor for further inquiry.

pro.bloombergtax.com - Common IRS Audit Triggers - Bloomberg Tax

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5. Earning Substantial Income

Earning a lot of income indicates a higher potential for tax-avoiding transactions. Individuals who earn more than $200,000 are much more likely to attract the attention of the IRS than individuals earning less than that amount because individuals with higher income tend to have more investment income that require more complex reporting such as real estate transactions, capital gains, or employer-stock options, and these attract IRS scrutiny. [See 501 TM, Gross Income: Overview and Conceptual Aspects; TPS ¶1010.01]

6. Being Self-Employed and/or Working as An Independent Contractor

It is easier for income to go unreported and business and personal assets to get comingled for taxpayers who carry on a trade or business as a sole proprietor or an independent contractor, are in a partnership or LLC that carries on a trade or business, or that are otherwise in business for themselves (including part-time businesses). Small businesses attract the attention of the IRS and filing Form 1040 Schedule C, Profit or Loss From Business, as a self-employed taxpayer raises the chance for an audit. Such taxpayers should be prepared for an audit by keeping excellent records and may consider incorporating or forming a limited liability company (LLC). [See 391 TM Employment Status – Employee v. Independent Contractor; TPS ¶4220] [For standard deductions, ERISA, Tax Code Pensions, standard mileage rates and more, visit our 2021/2022 Quick Tax Reference Guide]

7. Taking a Home Office Deduction

Taxpayers often believe that, if they work at home, they can automatically deduct expenses related to the business use of space in their home. Eligibility for deducting expenses related to the use of a taxpayer’s residence for business purposes when they have a home office is subject to very strict rules and the IRS will be interested to investigate if taxpayers taking this deduction are in compliance. The deduction will be disallowed for taxpayers who don’t actually use the space as an office, don’t strictly maintain the space for business use, or don’t otherwise strictly comply with the rules. Unfortunately, most taxpayers who are employees who have been working from home due to the COVID-19 pandemic are not eligible to claim the home office deduction. [See 547 T.M., Home Office, Vacation Home, and Home Rental Deductions; TPS 2460.04]

8. Claiming a Hobby as a Business

While expenses relating to the production of income or to investment activities are generally deductible, the hobby loss rules limit the deductions for activities not engaged in for profit. Taxpayers may deduct expenses that fall under §183 only to the extent of gross income from that particular activity during the tax year, so in essence, losses attributable to activities not engaged in for profit are disallowed and the IRS recently updated its guidelines for scrutinizing these activities. Note that hobby loss deductions are subject to the 2% limit on miscellaneous itemized deductions, which are not available for tax years beginning after December 31, 2017, and before January 1, 2026. [See 548 TM, Hobby Losses; TPS ¶2450]

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