Audit Flags

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What are some IRS audit red flags?

Audit Flags Tip: There are a variety of areas involved on tax returns where the IRS may scrutinize more closely. These areas are known for incorrect tax reporting and possible abuses. In technical terms, they are known as IRS red flags. Here are some areas you need to concern yourself about to avoid receiving any IRS red flags:

Home business office. Many taxpayers claim this deduction but do not meet the criteria guidelines. This area involves many IRS rules and regulations that must be followed in order to qualify for this tax deduction. Know the IRS laws prior to making any claim. The IRS will especially take notice if you operate a home business with little income, while you are claiming many expenses related to it.

Questionable business deductions. Whenever your tax return contains business deductions that appear unreasonable or do not relate to anything else on your tax return, the IRS will notice.

Your business deductions are much larger than your business income.

History. If you have a history of IRS audits, your tax return will be scrutinized more closely by the IRS.

Tax-shelter losses. This is a heightened area of scrutiny with the IRS. Your tax return will stand out.

Itemized deductions. Whenever your itemized deductions (especially involving medical, taxes, and interest) are beyond the acceptable IRS limit, your tax return will stand out.

Earned income credit. This area has received abuse and is now being more closely scrutinized by the IRS.

File separately. If you are married, yet file separately from your spouse, this can increase the chance of having inconsistent information between the two tax returns that you file.

Shareholder. By being a shareholder of a corporation that has been audited by the IRS, your tax return will be monitored more closely.

Charitable contributions. Whenever you are claiming charitable contributions, your income will be taken into consideration. If you are claiming a deduction for more donations than what it appears your income level warrants, the IRS will question that.

No explanation. Whenever you are reporting transactions (business or personal) that are ‘out of the ordinary', you need to send along an explanation of why you are treating the item the way you are. If you do not send this explanation, the IRS will question it.

Cash. The IRS will scrutinize more closely why you are receiving large sums of cash from your business transactions.

Underreported income. The IRS will monitor you when they notice you have an excessive amount of underreported income on your tax return. Information they receive from third parties does not match the information you report on your tax return. This will set off a “red flag”.

Tax preparer. If your tax preparer is on the IRS list of “suspectible tax preparers”, your tax return will stand out. This individual has a history of violating the IRS tax laws and is known as a problem preparer.

Informant. Also, if a third party informant has contacted the IRS about knowing you have received income and not reported it, the IRS will stand up and take notice. They will research this area prior to be certain of its legitimacy prior to contacting you, however.

Even though only a small amount of tax returns are audited each year (it is estimated to be about 1%), it is important to know and understand the above-mentioned heightened areas of scrutiny.

Many taxpayers have an IRS tax problem due to the fact that they under-report income on their tax return. They have received income from sources that did not send them a 1099, for example. Even though you have not received a Form 1099 (the form used to report this income), the third party has sent the information to the



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