Sunday 5 March 2023

The Daily Money: Worried about a tax audit? Watch for these red flags

06:01

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The Daily Money

ALL THE MONEY NEWS YOU NEED TO KNOW

Sunday, March 5

For many Americans, hearing the name "Internal Revenue Service'' sparks feelings of dread.

There's another word that can send stress levels through the roof – audit.

An audit means your tax return was picked out of a batch for closer inspection. In 2022, 3.8 out of every 1,000 returns, or 0.38%, were audited by the IRS, according to a report evaluating IRS data from Syracuse University's Transactional Records Access Clearinghouse.

In recent years certain income levels have also drawn more scrutiny, with the IRS auditing taxpayers with incomes below $25,000 and above $500,000 at higher-than-average rates, according to government data.

Treasury Secretary Janet Yellen and acting IRS Commissioner Douglas O'Donnell have stated that the nearly $80 billion the IRS will be receiving from the Inflation Reduction Act won't go toward increasing audits above past levels for taxpayers who earn less than $400,000 a year.

But while your chances of being audited are slim, it could still happen. Returns can be selected randomly, but there are also red flags that can draw the IRS's attention. We've got tips for what to do to lower the odds that your taxes will draw extra scrutiny.

Important information: Are you ready to file your taxes? Here's everything you need to know to file taxes in 2023.

Double check your income before filing your tax return

Many audit notices are automatically triggered when your W-2 income tax form shows you earned more than what you reported, said Erin Collins, National Taxpayer Advocate at the Taxpayer Advocate Service division of the IRS.

That's why she recommends taxpayers make sure the income they note on their returns matches the income that's reported in official tax documents like a 1099 or W-2.

"We find a lot of taxpayers take their last pay stub (of the year) and use that number," Collins said. But that can cause confusion because that last pay stub may not cover their typical pay period.

Audits can also be triggered when several people try to claim the same child as a dependent. Collins says parents who file taxes separately should clarify who will be claiming a child on their return. They should also make sure that a grandparent or other caregiver doesn't attempt to claim a child at tax time if they don't fall within IRS parameters that would allow them to do so.

And taxpayers should double check their math. While technically not an audit, the IRS sent a majority of notices in the past couple of years to tax filers who'd made mistakes. The uptick was spurred by taxpayers not properly adjusting their income after receiving enhanced child tax credits and other pandemic-related relief.

What's your tax bracket?

There are new tax brackets every year, a key change that can affect your tax rate. The changes are implemented to account for inflation, which fluctuates from year to year.

If the IRS didn't tweak federal income tax brackets for inflation you'd probably wind up in a higher tax bracket that would require you to pay more since your salary is often adjusted for inflation.

Despite the annual changes, those earning higher incomes will always fall within higher tax brackets than their peers who earn less.

There are seven tax brackets, and the threshold for each rose for the latest tax year. For instance, the income threshold for the top tax rate, 37%, increased by $16,300 for individual filers in 2022 as compared to 2021.

Starting in 2023, people with Medicare Part B may be able to save money on their premiums, as well as their annual deductible.

How does retirement affect your taxes? It depends on your accounts.

401(k) and IRA contributions provide tax deductions now, but how do they affect your taxes in retirement? It depends on the kind of accounts you have.