5 Audit Red Flags to Watch for When Filing Your Taxes

The IRS in recent years has been conducting fewer audits of individual tax returns, and the pandemic is expected to further reduce that number. Still, no one wants to chance an audit.

The IRS will catch and correct basic math errors. But its computer system can also spot more serious irregularities that can trigger a full examination. Here are some red flags that could catch the eye of IRS auditors:

1. Failing to report all your income. The IRS gets copies of your W-2 as well as various 1099 forms that report income from interest, dividends, and retirement account distributions. Its computers can catch mismatches between the income you list on your return and what your employer and financial institutions are reporting. The IRS will then notify you of any discrepancy along with the additional tax or penalty you might owe. If you forget to report some income and catch the mistake before the IRS does, you can file an amended return.
2. Claiming unusually large charitable or other deductions. You may come under IRS scrutiny if you have deductions, say, for medical bills or gifts to charity, that are disproportionately large compared to your income. Of course, it could be that you had an expensive surgery or you're just more generous than others. If so, make sure you have the documentation to back up your deductions.
3. Dealing in cryptocurrency. The IRS has made no secret that it's looking closely at virtual currency transactions to uncover unreported income. The agency considers virtual money as taxable property. New for 2020 returns: Near the top of Form 1040, just below your name and address, the IRS asks if you have received, sold, sent, exchanged, or otherwise acquired a financial interest in any virtual currency.
4. Writing off losses from a hobby. You can deduct losses from a business, but not a hobby. The IRS keeps an eye out for taxpayers who deduct losses for what appears to be a hobby. To be considered a business, a venture must be done with the intention of making a profit and be run in a business-like manner.
5. Neglecting to take required minimum distributions. Congress waived Required Minimum Distributions (RMDs) in 2020 because of the pandemic. But RMDs are back for 2021, so make sure you take them if required — or risk getting audited in the future.

You must take annual minimum distributions from traditional IRAs and workplace retirement accounts, such as 457, 403(b), and 401 plans, after age 72 (70½ for those born before July 1949). If you're still working when you hit the RMD age, you don't have to take distributions from your current employer's retirement plan. But you will need to take distributions from any former employer's plan. Learn more about RMDs.