Does Filing Bankrupty Trigger A Tax Audit?

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No. The IRS will only verify that you have filed all tax returns that were due at the time you filed your bankruptcy case. There are 10 indicators that you should be aware of that can trigger an IRS audit.

  1. High income. We all know the saying “follow the money”. So it just makes good sense that the IRS will go where they feel they can get the most money for time spent and that is on higher income filers.
  2. High charitable deductions. Documentation requirements are strict in this area and if you are claiming high amounts, which can offset up to half your taxable income, you need to make sure you have your documents in place.
  3. Certain professions. Professions that combine high income and/or have a high potential for dealing in cash (ex: auto dealers, cab & limo drivers, etc) are selected as professions that have higher potential for not reporting all income.
  4. Failing to report income. The IRS receives copies of W2, 1099s, and other documents that report income you received. If they are receiving notice of income that you did not report on your tax return, it could flag your return for review.
  5. Home office deductions. The requirements that must be met to properly take this deduction are listed on the current form 8829 and is a 43-line long exercise in math. In other words, it’s hard for them to believe you qualified so they might want to double check.
  6. Real estate losses. The IRS offers a very narrow definition of real estate “professional” so if you don’t qualify as a pro – you have red-flagged your return by claiming this type of loss.
  7. Schedule C losses. If you run a small business, you may have losses starting up, which is understandable. However, the IRS expects you to be reporting a profit in 3-5 years. If not, the IRS may come knocking to see if you are running a business or something that they would classify a hobby but trying to claim as a business loss.
  8. Gambling losses. If you have winnings, you must report it regardless and then you can report your losses as an offset. If you have no winnings however, you can’t write off losses. Claiming a net loss is a potential flag.
  9. Adoption tax credit. This credit is significant and requires very specific documentation so be sure you have what is needed.
  10. Missing or frivolous information. Signatures, dates, social security numbers and filing status are items that, if missing, will result in the IRS sending your return back to you. If the return itself doesn’t offer enough information or has writing on it that is not needed, it may be deemed “frivolous” and can result in a $5,000 penalty.

Of course, the IRS will not share their specific formula for deciding who they will audit and when. Their formula for who and what receives an audit has been a hot topic lately due to the IRS being under fire over accusations of targeting Tea Party members. An IRS supervisor in D.C. admitted to overseeing such activity according to The Washington News.
But it’s not a good game plan to try to avoid an audit or depend on not being in the small % that is called up for one – but rather you should keep good records, honestly report all income, and use a reliable tax service to ensure you properly file your information with the IRS as required by law.

Disclaimer: This blog is intended as general information purposes only, and is not a substitute for legal advice. Anyone with a legal problem should consult a lawyer immediately.

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