Many clients wonder, what issue(s) are IRS audit red flags?  While the IRS has a very sophisticated system to select tax returns for audit, there are several issues that are, anecdotally, red flags for an IRS audit.

  1. Matching – third-party income information reporting has become a major tool in administering our tax Code.  Information returns like W-2’s, 1099’s, and more tell the IRS about what someone else paid you.  Failure to include those items on your tax return is one of the first IRS audit red flags.
  2. High Income Earner – those with higher than average income are at a higher percentage of being audited.  Similarly, great swings in income (either from high income to low income, or low income to high income) can be an IRS audit red flag.
  3. Large Schedule A Deductions – Schedule A deductions include, among others, charitable deductions, mortgage interest, unreimbursed employee business expenses, and more.  Those who claim high itemized deductions on Schedule A, particularly unreimbursed employee business expenses and charitable contributions, could be more susceptible to an IRS audit.
  4. Consistent Losses – systemically report losses on a tax return (either for a business on Schedule C, rental activities on Schedule E) can be an IRS audit red flag.  The theory often is, how can a taxpayer afford necessary living expenses that are otherwise not deductible if they have no taxable income?  Or, is the taxpayer engaged in a business or trying to use losses from a hobby to offset other income?  Having large and/or recurring losses is an IRS audit red flag.
  5. Deducting Certain Entertainment, Meals and Entertainment, and Travel Costs – in a Schedule C IRS audit, travel, car & truck, and meals & entertainment are very common audit issues.  The law under IRC § 274 generally places a higher burden on taxpayers to substantiate these expenses.  Because of common abuses, having large deductions for these specified expenses can be an IRS audit red flag.

Kevan McLaughlin is a San Diego tax attorney at McLaughlin Legal, where the firm defends taxpayers before the IRS, FTB, BOE, EDD, Department of Justice, and more.

San Diego tax attorney Kevan McLaughlin highlights 5 issues that may be IRS audit red flags.

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