Common Red Flags That May Trigger an IRS Examination or Investigation

There are many things that could trigger an IRS investigation, such as someone having a wrong name or Social Security number on their returns, incomplete or missing information, a mismatch between the federal and state tax returns, or filing an amended tax return. Even having too many round numbers, especially on the business side, means someone is most likely estimating their business income or expenses. They are estimating by pulling numbers out of thin air just to get it done with, but that can prove to be very problematic in the future.

You should contact our experienced tax audit attorney if you are made aware of an investigation or believe your returns have red flags that might trigger an investigation.

What Are Some Common Red Flags the IRS Looks For?

There is a large laundry list of red flags that might cause the IRS to closely examine a taxpayer, including:

A taxpayer has been audited before
The income and expenses closely resemble another taxpayer in a similar situation
There is a large refund
There is a net operating loss, where you have carried over a loss from a previous year
Frequent cash transactions, especially for small businesses
Unreimbursed employee expenses
Frequent reimbursements for meals, entertainment, and travel
Losses from a of a rental property
Frequent stock trades

Working With an Unscrupulous Tax Return Preparer

There are many tax preparers who are ethical and competent, but there are also others who are not, and tend to overstate deductions, trying to get a refund from the IRS that goes into their own pocket. So, they have an incentive to bump up deductions and bump down the income.

Charitable Contributions

The valuation of charitable contributions, especially non-cash contributions, is sometimes overstated by the taxpayer. We would recommend a client to be very conservative in valuing non-cash contributions, and perhaps not even take a deduction for a bag of old clothes that are not worth anything. It is just not worth the chance of an IRS audit.

Home Office Deductions

It can be hard to get this small business owners’ deduction, as you must follow a variety of rules in terms of keeping track of the space and using the space solely for business purposes. Often this deduction should be based upon the percentage of the home being used for work.

Small Business Schedule C Losses

This occurs when an individual has a “side hustle”, and they are trying to offset the income tax from their wages. If the Schedule C job is more like a hobby, though, and is not really a business, the IRS may disallow those losses. Mileage and vehicle expenses for the small business owner also tend to get audited all the time.

Foreign Bank Accounts and Tax Shelters

Most people do not know this, but if they have foreign financial accounts that total more than $10,000, this must be reported on an FBAR. Additionally, individuals who receive foreign income must report this on their US Tax return. The U.S. is one of the few countries in the world that taxes its citizens on a worldwide basis. The IRS may notice that the taxpayer has not disclosed foreign income or accounts, and an audit could be triggered based upon that. If a taxpayer has not reported income from a foreign trust, and there are a lot of cross-border transactions, that is another potential red flag.

Syndicated Conservation Easements

Syndicated conservation easements have gotten a lot of press recently. As an example, a person could buy a property for a particular amount of money, and say it is worth 100 times that amount. They then break that property into a partnership, and try to take a tax deduction for 100 times the value that they purchased it, and sell those deductions to hundreds of partners. This could easily cause the IRS to begin an examination.

Call Us If You Think You Have Red Flags That Will Trigger an IRS Audit

There are many inconsistencies, suspicious changes, or general errors in your tax returns that could lead to an IRS examination or audit. That does not mean you did anything wrong or that the IRS will automatically find wrongdoing. However, it is good to know about these red flags so you can avoid them; and contact a tax attorney if an audit commences. We can explain what actions you can take to carefully address the concerns and respond to the audit.