Tax season can feel like walking a financial tightrope. You want to take advantage of every deduction available, but the last thing you need is the IRS knocking on your door with an audit notice. While deductions help lower your taxable income, some raise red flags.
So, which deductions could put you in the spotlight? Here are 11 that might make the IRS take a second look at your return. If you’re claiming them, be extra cautious and keep detailed records in case Uncle Sam comes calling.
Home Office Deduction
Working from home has become the norm for many, but claiming the home office deduction can be tricky. The IRS requires the space to be used exclusively for business, not as a part-time guest room or workout space. Expect scrutiny if you’re writing off a big portion of your home.
Excessive Charitable Donations
Generosity is wonderful, but claiming huge charitable donations compared to your income might catch the IRS’s attention. The agency has statistical models to compare your giving habits to similar earners. The IRS reported that taxpayers earning between $50,000 and $100,000 typically donate about 2% to 3% of their income. If your donation percentage is significantly higher, be prepared to provide proper receipts and documentation.
Unusually High Business Expenses
Small business owners and freelancers often write off expenses, but it could raise eyebrows if your deductions seem out of line with your income. The IRS knows what’s typical for different industries. Keep records, receipts, and a clear business purpose for every deduction you claim.
Earned Income Tax Credit (EITC)
The Earned Income Tax Credit is a great benefit for low- to moderate-income taxpayers, but it’s also a common source of fraud. Because of this, EITC claims are closely examined. In 2022, the IRS estimated that about 32% of EITC payments were issued incorrectly, leading to increased audits. If you qualify, double-check that you meet all requirements and have proper documentation.
Large Unreimbursed Employee Expenses
Before the tax laws changed in 2018, employees could deduct unreimbursed work expenses exceeding 2% of their adjusted gross income. While this deduction no longer applies to most people, certain professions—like performing artists and reservists—can still claim it. If your expenses seem too high, the IRS may investigate whether they were truly necessary for your job.
Rental Property Losses
Owning a rental property can come with tax advantages, but reporting losses year after year can make the IRS skeptical. Generally, if your adjusted gross income exceeds $150,000, you can’t deduct passive rental losses unless you qualify as a real estate professional. If you claim significant losses, have records to back up your numbers.
Cash-Based Business Income
The IRS may pay closer attention if you run a business that deals primarily in cash—like a restaurant, salon, or handyman service. Cash transactions are more complex to track, and the IRS always looks for unreported income. Keeping meticulous records is key to avoiding issues.
Gambling Losses
You can deduct gambling losses, but only up to the amount of your winnings. The IRS may suspect foul play if you claim large losses without significant winnings. Casinos and betting establishments issue Form W-2G for big winnings so the IRS knows when you’ve hit the jackpot.
Unreported Foreign Accounts
The IRS takes foreign income and accounts very seriously. If you have more than $10,000 in a foreign bank, you must report it. Failing to do so can lead to hefty penalties. If you have foreign investments, file the necessary forms to stay on the right side of the law.
Medical Expense Deductions
Medical expenses can be deducted if they exceed 7.5% of your adjusted gross income. However, claiming unusually high amounts can put your return under the microscope. The IRS has guidelines on what qualifies as a legitimate expense.
Hobby Losses
Turning your hobby into a business sounds great, but the IRS has strict rules. If your activity isn’t profitable for at least three out of five years, it’s considered a hobby—not a business. Claiming losses year after year can raise suspicions.
Disclaimer – The Finance Key does not provide and does not intend to provide financial, investment, tax, or legal advice. Information contained in this article is for informational and educational purposes only. This list is solely the author’s opinion based on research and publicly available information. The inclusion of links to third-party content is not an endorsement by The Finance Key of such content or services. Please do your due diligence and use your discretion.
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