The Top 10 Red Flags for a Tax Audit

In order to verify accuracy and conformity with tax rules, a tax authority (such as the Internal Revenue Service in the United States) will formally examine a taxpayer’s financial records and tax returns. Audits are carried out to confirm that the taxpayer has accurately declared their income and deductions and to spot any inconsistencies or possible tax evasion. The taxpayer may be asked to pay additional taxes, fines, or penalties if problems are discovered during the audit.

 

Who is subject to a tax audit?

Based on their income and business activity, certain people and entities are subject to undergo tax audits:

Businesses

According to Section 44AB of the Income Tax Act, if a person is carrying on a business, they are subject to a tax audit if their total sales, turnover, or gross receipts for the year exceed Rs. 1 crore. However, if they opt for the presumptive taxation scheme under Section 44AD and their total sales or turnover doesn’t exceed Rs. 2 crores, they are exempt from the tax audit requirement. Additionally, the threshold for businesses is increased to Rs. 10 crores if more than 95% of their business transactions are conducted through banking channels and cash receipts/payments do not exceed 5% of the total receipt/payment.

 

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Professionals

Individuals engaged in a profession are subject to a tax audit if their gross receipts in that profession for the year exceed Rs. 50 lakhs.

 

The Top 10 Red Flags

Audits can be triggered by various factors, and while these aren’t definitive guarantees of an audit, they can raise red flags. The top 10 warning signs are as follows:

Large Income Disparities

Earning a substantial income can attract scrutiny, especially if it’s significantly higher than in previous years.

Unreported Earnings

An audit may result from failure to disclose all sources of income, including cash payments, rental income, and freelancing.

Hefty deductions

Claiming disproportionately significant deductions in comparison to your income or industry standards can raise red flags because it may appear that you’re trying to artificially lower your taxable income.

Cash Transactions

Particularly in a commercial setting, a high amount of cash transactions can draw attention because they are frequently linked to undeclared revenue and possible tax fraud.

Excessive Business Expenses

An audit may be initiated if you declare business expenses that are exorbitant, unjustified, or disproportionate to your income.

Frequent Amended Returns

Regularly updating your tax returns may be a sign that there were errors in your initial filings, which can trigger an audit when the authorities check your financial information.

 

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Foreign Accounts

Because tax authorities are pursuing offshore tax evasion aggressively, failing to disclose offshore accounts or foreign income may result in an audit.

Information inconsistency

Giving contradictory or inconsistent information on various tax forms from different years can raise red flags because it could imply errors or possible attempts to manipulate your tax liability.

 

Read More: How to respond to an erroneous notice from the I-T Department

 

High Tax Deductions for Charities

It can be suspect if you claim significant charitable deductions without the appropriate paperwork or in relation to your income.

Losses in business

Reporting business losses year after year could raise questions since some people might use them to artificially reduce other revenue. To verify the validity of these losses, tax authorities might conduct an investigation.