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You’d think retirees would get some consideration from the IRS. I mean, they’ve worked their entire adult life, paid their taxes (well, most of them), and paid them no matter what administration was in office or what stupid rules an administration put on the books. Now they’re retired. But it doesn’t mean retirees are exempt from IRS audits.

The reasons you might get audited vary depending on your situation, but might include:

1. The complexity of your return
2. Types of tax deductions you claim
3. If the amount of deductions you claim is outside the parameters of what the IRS says is “normal”
4. Or if you’re still involved in a business

The other factor that could increase your chances of getting audited is the $80 billion given to the IRS in last year’s Inflation Reduction Act, a big chunk of which will go to hire 87-thousand new IRS agents who will allegedly go after more high net worth individuals and pass-through entities such as LLCs, S Corps, and limited partnerships. The IRS says taxpayers earning less than $400,000 a year won’t see an increase in audit rates. We’ll see.

But as a retiree, there are some specific red flags that could prompt the IRS to see if you’re telling them the truth. For example:
 

Failing to Report All Taxable Income

How does the IRS know if you didn’t report some income? Because people who give you money are required to report it to the IRS in the form of

• 1099s (and there are several)
  • 1099-income received from working for someone
  • 1099R-payouts from retirement plans, pensions, 401(k)s, annuities and IRAs
  • 1099SSA-Social Security benefits
  • 1099K-online payment sources such as PayPal, Airbnb, Etsy, etc.
• W-2s

When the IRS receives those forms, they check it against what you told them, and if there’s a discrepancy, red flag!
 

Failing to Take Required Minimum Distributions (RMD)

The IRS wants to make sure they get the taxes on money you’ve saved but didn’t pay taxes on already—particularly IRAs, 401(k)s, 403(b)s, and other workplace retirement plans. As part of the deal, you were allowed to save money on a pre-tax basis knowing that you’d have to pay the IRS piper sometime in the future, when you reach a certain age, in the form of Required Minimum Distributions (RMD). You pay taxes on those distributions at the ordinary income rate.

The rules for when you have to pay up were modified by the SECURE Act 2.0. You have to take RMDs:

• At 73 if your birthday is January 1, 2023, or after
• Age 72 if your birthday was between 2020-2022
• The RMD age increases to 75 beginning January 1, 2032

If you fail to take your RMD – and, yes, the IRS will know – you’ll pay a penalty of 25% for all RMDs beginning in 2023 and a 50% penalty for undistributed RMDs prior to 2023.
 

Deducting Large Losses

One of the things that may pique the IRS’ interest in your tax return is deducting disproportionately large losses compared to your income. It could be:

• A really big medical expense
• A big loss from the sale of rental property
• Big investment losses
• Big losses that offset income from wages, pensions, or other sources
• Big deductions for bad debt or worthless securities

The key to deducting any big loss is proof. If you’ve got the proper documentation then claim the loss. Don’t pay the IRS more than necessary when you can do it legally according to the rules in the IRS code.
 

Claiming Large Charitable Deductions

Just like large losses, extremely large charitable donations compared to your income can send up a red flag. The IRS knows what average charitable donations are for people at your income level. How do you protect yourself? Be able to prove it.

• Get charitable giving statements from the organizations you give money to.
• Get a written appraisal for donations of property valued at more than $5,000.
• Make sure you have all the proof If you’re an investor in a partnership, LLC, or trust that donated a conservation or façade easement to charity.
• Make sure you have all the proof if you donate non-cash items valued at more than $500 if you don’t file IRS form 8283.

Proof, proof, proof. Have everything you need to defend your deduction.
 

Claiming Rental Losses

Be careful claiming large depreciation deductions on Schedule E that end up generating a tax loss from rental activity. Generally, the passive loss rules prevent the deduction of rental real estate losses, with two exceptions.

• If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. This $25,000 allowance phases out as modified adjusted gross income exceeds $100,000 and disappears entirely once your modified AGI reaches $150,000.
• Real estate professionals who spend more than 50% of their working hours and more than 750 hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off rental losses.
   

Owning a Business

Schedule C can be loaded with tax deductions from self-employed individuals. The IRS takes a hard look at sole proprietors reporting at least $100,000 in gross receipts, cash-intensive businesses, and business owners who report substantial losses and have income from other sources.

And if you’ve got a side hustle in retirement that the IRS considers a hobby, such as dog breeding, jewelry making, horse racing, stamp collecting or the like, and you try to turn it into a moneymaking venture, know the tax rules.

To deduct a loss, you must be running the activity in a business-like manner and have a reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the IRS says you’re in business to make a profit.
 

Neglecting to Report a Foreign Bank Account

Retirement plans for some folks include traveling—sometimes outside the country. And some find it easier to have money outside the U.S. The IRS doesn’t mind you having money in a foreign bank, they just want to know about it.

If you don’t want to get hit with penalties, you have to report any foreign bank accounts you have. You electronically file the Report of Foreign Bank and Financial Account form. If you have more than $10,000 outside the country you may also have to attach IRS Form 8938 to your Form 1040 or 1040-SR.
 

Failure to Report Gambling Winnings or Losses

And then there are those retirees who enjoy the thrill of gambling, whether it’s traveling to Las Vegas or other casinos around the country, heading to horse tracks, or just betting on sporting events while you sit at home. The reality is, if you win, gambling organizations have to report it to the government on IRS Form W-2G. If you don’t report it too, it will come back to haunt you.

Gamblers fall into two categories with the IRS. Recreational gamblers have to report their winnings under the “other income” section of Form 1040.  Professional gamblers list their winnings on Schedule C.

Winning and not reporting it puts you on the IRS naughty list. Claiming large gambling losses can also put you there. Losses can only be deducted to the extent you report gambling winnings.

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