IRS Tax Audit Red Flags

The IRS selects audits based mostly on compliance and the Discriminant Income Function (DIF) score. Returns that have the highest potential for errors and additional tax assessments may be selected for audit.

Some cases are…

Home Office Deduction

We’ve found that many times the tax savings isn’t worth the risk. Especially the depreciation. Once you commit part of your house to business use, you have to pick up any gain on sale from that portion as ordinary income. This in effect reverses the benefit of the deduction. This deduction gets abused by taxpayers who tend to write off a larger portion than what was used, especially if they already sold the house. Also, personal expenses tend to get apportioned incorrectly to the business portion of the house. This is a major red flag

Rental Property

People often make incorrect assumptions regarding the rules associated with rental property. There are dealers, investors, and often classifications, such as active and passive. Passive losses may only be limited to $25,000 and phased out for high income taxpayers. Material participants can deduct their bases in full. Incorrect classifications cause taxpayers to deduct more than they should. Non deductible expenses are found on tax returns, too. The IRS red flags the returns with rental property as returns with potential audit adjustments.

Charity

People often do the following incorrect things on their returns pertaining to charity; they…

1. …Deduct too high of a value for donated items to charities
2. …Deduct amounts greater than actually paid for religious donations
3. …Overstate the fair market value of property they donate
4. …Deduct amounts that are extremely large in relation to their earnings
All items on returns should be explained when they exceed what the IRS would generally expect. Don’t know what they expect on returns? We do! Please consult us if you are being audited or have unusual tax return circumstances. CPA firms are the professionals best suited for these matters.

Sales Properties – Schedule C

Sometimes employers who are paid on a W2 form will put their business expenses on the form. This is incorrect. Schedule C is to be used by self employed individuals. These people invoice their customers and are paid directly. They may be paid indirectly and issued a 1099. This is the tip of the iceberg. The biggest reason most business audits by far are Schedule C’s is because people deduct everything in the world except “the kitchen sink.” Correction, they deduct that, too. Every expense must meet the IRS guidelines for deductability before you deduct it. You can’t just say that it’s some how related to business so therefore it must be deductible. Self employed people have been hiding income at such a high rate that auditors will make all your bank deposits’ income unless you can prove which deposits are not.

Employee Business Expenses

This form is often prepared incorrectly. You must be a salaried employee. The expenses incurred have to be a condition of employment and for the convenience of the employer. Other rules concerning reimbursement, ordinary and necessary, and deduction limitations exist. The amounts from this form carry to Schedule A. There is room for error and abuse on this form. The IRS will send the case to Criminal Investigation if they think you are fraudulent claiming job expenses. Please consider having us represent you.