Let’s begin with a conclusion. If yourtax returnmakes sense and everything is well explained, then you will likely never encounter the worry and pain of going through anIRS audit. You will be able to avoidIRS auditred flagsand hiring atax attorneylike myself.
My advice is to take the extra time going over everything, making sure all the reportedtaxable income,tax creditsandsupporting documentswith your return are in order. If you do, you can also avoid spending a significant amount of time digging out old records, and in the end, quite possibly saving a lot of expense, too.
If you read anything about the IRS this year, you’ll know that they are playing “catch up,” with millions oftax returnsfrom 2021 due to budget cuts, layoffs and the pandemic. However with the recent influx of cash from the Biden administration, they should manage to get caught up soon.
In any case, if you are still worried bout being audited this year and would like to know what are thered flagsforIRS auditor about the IRSred flags2023, I’ve provided a list of 25 factors that are often considered.
The first threered flagscould be filed under the topic of “mistakes.” They all suggest thetaxpayerdid not use proper due diligence and care when preparing their return. Mistakes on atax returnmean that things need to be changed and those changes may mean an increase in tax owed to the government.
In addition, some mistakes cause the return to get kicked out of the electronic processing system and rerouted somewhere else. This generally requires a human to correct it.
1. Wrong Name or Social Security Number
I know, typos happen. So do audits. Check your work before the IRS does.
2. Incomplete or Missing Information
It is very important to make sure the information in your federal and any statetax returnsmatches up. The IRS and the stateincome taxagencies can and do share information regardingtax returnsthat are filed. A mistake in that arena can potentially mean that both agencies come knocking on your door
3.Math Errors
Again, quite a few people add upbusiness expensesandwrite offsand makemath errors. If there’s a lot of math (especially in the form of deductions) on your return, get aCPAto at least take a look at it before you file it.
4. Amended Returns
Amended returns will probably generate closer scrutiny by the IRS. Filing an amended return, particularly if it results in a significant decrease in tax, is almost guaranteed to get a second look by the IRS.
It may not mean that your return will be selected for audit, but an amendedtax returnred flaggenerally means someone at the IRS will make sure that the return was done properly.
5. Too Many Zeros
Zeros, especially double or triple zero, indicate that thetax preparerguessed. I have seen IRS revenue agents (auditors) roll their eyes when they see complicated expense categories come out as a nice even number.
They often just know that thetaxpayeris not going to be able to substantiate that category fully.
6. Repeated End Numbers
Using the same end number over and over again may also raise ared flagwith the IRS.
I would never advise someone to guess on atax return, but if you are truly stumped and need to make your most honest recollection about an expense category then you might want to vary those guesses to avoid scrutiny.
7. You Have Been Audited Before
There is some debate about this among practitioners. Some people claim that getting audited once and having that audit result in a change opens up the door to future scrutiny down the road to the IRS. Others claim that once a person has been audited, the Service turns their attention to othertaxpayersto widen the number of people they are able to examine.
I find fault with both of these rationales and, although I have never had an audit client get audited twice by the IRS, I do not find it hard to believe that some variation of this information may make its way into your DIF or UI DIF score.
While this certainly is not a major factor or auditred flag, it is a good reminder for those who have been audited to make sure their I’s are dotted and their T’s are crossed when it comes to their return.
8. You Use An UnscrupulousTax Preparer
I cannot say enough about the dangers of using someone who fudges numbers on yourtax return, who is overly aggressive, or who may just be an all out crook. The IRS Criminal Investigation Division (CID) has been increasingly going after unscrupulous return preparers as a way of ushering compliance from the rest of the community.
Think about it. If your preparer magically turns a $300 balance into a $300 refund, okay, but if he’s doing it for you then he’s probably doing it for everyone.Tax preparersuse an identification number known as a PTIN, so that the IRS can readily and easily identify all the returns that they individually prepare.
The IRS has a number of ways that it discovers crookedtax preparers. Someone may rat them out to the IRS, usually a former client or former spouse. One of their clients may be audited and the IRS may take a second look at some of the other returns that they have prepared if the audit resulted in extensive changes.
Probably not too far off, if it does not already exist at the IRS, is a method to statistically look for patterns in the returns that a person has prepared. Think about a card shark who knows how to count cards. For a while, if they’re careful, they’ll get away with it, but eventually someone notices and someone usually gets hurt.
Regardless of how they are caught, you do not want to be anywhere near that person when they are caught.Tax preparershave been a high-priority target of the IRS for many years now.
Google “tax preparer,” and “sentenced,” to see what I mean. You should absolutely do everything in your power to avoid them, especially if they do not sign thetax returnsthat they prepare or indicate that the return was self-prepared.
9. Large Changes of Income
Most of these auditred flagsare thought to increase your DIF score. However, this is probably one of the main indicators of underreported income. There are many unexpected events in life that can cause changes in income such as a loss in job, a windfall gain, or just unexpected good or bad luck in life.
As such, unexpected and significant swings in income can usually be explained fairly easily. However, large inconsistencies in income from year to year may indicate an area of concern to the IRS if the change in income is not readily apparent (i.e. losses of a job would be reflected by a W2).
This is because large shifts in income can also be indicative of someone hiding income in a current or pasttax year. By taking a closer look at the income earned in different years (as well as the substantiating documents), the IRS can sometimes find discrepancies in what ataxpayerearned vs. what they reported.
10. Large Refunds or Net Operating Losses
Generally, the IRS has no issue with small refunds because predicting the exact amount of withholdings needed over the course of the year is a difficult task, especially when factoring in deductions. However, large refunds pose an entirely different problem for the IRS and it has nothing to do with them not wanting to write a large check to thetaxpayer.
First, most large refunds are not associated with standard W2taxpayers, but rather are indicative of large losses on ataxpayer’s return or something that has offset a large amount of tax that thetaxpayerwould have had to pay.
As a result, these issues are usually much more technical than a standard return and, therefore, the IRS will usually want to take a second look at those parts of the return to make sure you are right.
The good news is that if your calculations are right, your return may come off the manual reviewer’s desk in a short time, barring other problems. The same issue exists when ataxpayershows a net operating loss that is carried over from a prior year.
Because even many preparers make mistakes when reporting net operating losses on a client’s return, the IRS may examine this section of it due to the potentially high margin of error.
11.Foreign Bank Accounts
Even thoughtaxpayersmay have perfectly legitimate reasons for engaging in cross border transactions or may own property in other countries, such activities traditionally make the IRS nervous for a variety of reasons.
First and foremost, the IRS summons authority and the ability of the IRS to demand records from third parties (banks, financial institutions) in foreign countries is extremely limited. Particularly in countries with strong bank secrecy laws. The IRS may not find out about the existence of these assets unless they are voluntarily disclosed by thetaxpayer.
12. Income From Foreign Trust
The IRS can seek prosecution if ataxpayerlies about income from a foreign trust and is particularly cautious of US persons that do. Although the IRS will not audit everyone who has assets or transacts business internationally, your risk of an audit may increase if you do.
13. Frequent Cross Border Transactions
Cross-border transactions and hiding assets in foreign countries are often used methods to evade taxes. As such, the IRS now requirestaxpayersto disclose if they haveforeign assetson theirtax returns.
14. Participating in a Tax Shelter
Yeah, that one is easy.
15. Cash Transactions
Cash is a major auditred flagbecause it creates all sorts of problems for the IRS. It is almost impossible to track cash transactions, can be easily hidden, does not have a clear electronic record to keep track of it, and is difficult for the IRS to verify.
One of the big fights that the IRS has been waging for years has been against cash businesses. Hospitality workers who do not report their tips, taxi drivers who collect off-meter fares, retail store owners who sell merchandise off-book, etc.
Cash transactions go unreported by a great manytaxpayers, many of whom believe that they do not have to report the cash (wrong) or who figure that the IRS will never know that thetaxpayerreceived cash.
Specifically, the IRS targets returns wheretaxpayersmay deal with large amounts of cash and consider it an auditred flagwhen a return contains a high probability ofunreported income.
16.Charitable Contributions
Inflatedcharitable contributionsare one of the most abusedtax deductionsand, as such, one of the biggestred flagsthat a return is deserving of an audit.
In addition, manytaxpayersfail to include the required schedule for non-cash contributions to charities, which is indicative of either a false deduction or the fact that thetaxpayerlacks the proper substantiation requirements under the Internal Revenue Code (resulting in a disallowed deduction).
In any event, the IRS often challenges non-cashcharitable contributionsbecause there is at least some potential for change and resulting in additional revenue for the IRS.
17. Unreimbursed Employee Expenses
Unreimbursed employee expenses are perceived to be one of the most common IRSred flags. The IRS frequently reviews unreimbursed employee expenses in audits, as they are widely considered a high abuse category for W2 employees.
As a practitioner, when reviewing an audit client’stax return, I often do a quick calculation to determine what percentage ofadjusted gross income(AGI) do unreimbursed employee expenses total. Anything over five percent (5%) and I make sure to ask my client about the nature of the expenses taken.
Think of it this way – an employer is not likely to pay you a salary only to turn around and make you spend more than five percent (5%) of it on the cost to do your job. If that is the case, these expenses are usually reimbursable to the employee by their employer.
The problem with unreimbursed employee expenses is that many people either throwpersonal useexpenses into this category or add things that are nottax deductible(like dry cleaning expense).
The IRS is catching on quick, however. Not only do they monitor your total Schedule A expense (as a percentage of income), but they compare it to others who have your occupation and flag the outliers for additional screening.
Given the history of abuse associated with this category, it is important to be vigilant when totaling your expenses to make sure they meet the requirements of the Internal Revenue Code. Be prepared for the government to take a look at these expenses, as they are one of the common IRSred flags.
