Watch Out! Don't Raise These 5 IRS Red Flags on Tax Returns
John F. Dennehy Jr., CPA, PC

Tax Returns

Watch Out! Don’t Raise These 5 IRS Red Flags on Tax Returns

It’s tax season, which means it’s imperative for you to know the most popular IRS red flags on tax returns. Whether you have a sole proprietorship, S-Corp, partnership, corporation, or any other type of business, the Internal Revenue Service will utilize an array of human and automated processes to quickly select which tax returns should be audited.

In short, every tax return will be compared to statistical norms. If your tax return is selected for an abnormality, it will undergo three different layers of review by IRS personnel. Then, the actual audit can occur in a meeting at your place of business or via mail. In either case, an IRS audit is unpleasant, and sometimes may be unavoidable.  

Being notified your business or personal tax return has been selected for an audit can be jarring. However, you can help reduce the likelihood by understanding some of the most common IRS red flags on tax returns. Continue reading to learn more about some of the most common IRS red flags on tax returns and how you can reduce the likelihood of an audit.

Earning Over $200,000 Is an IRS Red Flag on Tax Returns

Did you know in 2018 the IRS audited approximately 1% of those who earn less than $200,000, while more than 4% of those earning more were audited? If you increase the threshold to $1,000,000, the number of those audited jumps to approximately 12.5%.

When it comes to business tax returns, this exact pattern exists: only 1% of businesses that earn less than $10 million are audited, while approximately 17.6% of those who earn more are audited. Simply put, higher incomes are more likely to create complex tax returns with more audit triggers.

Most importantly, the Internal Revenue Service wants to maximize their ROI, which is one area the IRS seemingly gets better at each year. The IRS has experienced a 63.8% increase in collection enforcement since 2001 without making an adjustment for inflation. However, during this time there has been a mere 9.8% increase in IRS enforcement personnel.

Income IRS Red Flags on Tax Returns

Undoubtedly, income that is unreported is potentially the easiest-to-avoid IRS red flag on a tax return. Yet, it’s also the easiest for the average person to overlook. Any institution distributing income will report it to the Internal Revenue Service.

And the more sources of income you have, the more difficult it will be to keep track. One of the most commonly overlooked sources of income are old brokerage accounts as well as Form 1099s. It’s important to consider:

The IRS typically receives a copy of every tax form you do, including all distributions of income.

The IRS works to match all reported items to your income tax return. If at any point they notice something wrong, it will serve as an IRS red flag on your tax return. This discrepancy will automatically create a letter of audit — at the very least.

Blurred Lines on Business Expenses

If you want to send up a flaring red flag to the IRS on your tax returns, using excessive business tax deductions will do just that! Pay special attention to the following:

  • Make sure you know any take-home vehicles are not considered strictly business. As a result, you should provide a specific purpose for any vehicle related deduction.
  • The IRS uses occupational codes to gauge normal amounts of travel based on profession. A tax return showing more than 20% may warrant a second look.

Typically speaking, the IRS can be very strict when it comes to mixing personal and business expenses. While business meals may be allowable, exceeding the standard occupational norm by a significant amount almost welcomes an audit. Business meals within itself are a blurred line. However, you can make sure to protect yourself by documenting business meals that are not a personal expense.

Not Complying to Foreign Account Rules

The Foreign Account Tax Compliance Act lays out extremely strict requirements for reporting when it comes to foreign bank accounts. Most notably:

  • Individuals are required to use Form 8938 to report foreign assets worth at least $50,000.
  • This law requires foreign banks to provide information about American account holders to the IRS.

Previously, you were not required to report foreign accounts; you only needed to check a box to signal you actually had one. Today, you’re not only required to check a box, you must identify the bank or financial institution where the account is and identify the highest dollar amount the account held in the previous year.

This law requires openness, which may increase the possibility of an audit. Primarily, this is due to the notion taxpayers with a foreign account are attempting to hide offshore income. Yet, the Catch 22 is compliance with the Foreign Account Tax Compliance Act actually increases the likelihood of an audit, while noncompliance may result in significant legal liabilities and/or stiff financial penalties.

Contact Dennehy CPA & Reduce the Likelihood of an Audit  

If you’re looking to reduce the chances of an audit, the tax planning and accounting experts at Dennehy CPA can help. We offer decades of experience helping businesses and individuals successfully file income tax returns. By having your taxes filed by the professional team of CPAs at John F. Dennehy CPA, PC, you can rest easier. And in the rare instance your tax return is audited, Dennehy CPA will be there with you every step of the way.

Contact Dennehy CPA today.

About the Author John F. Dennehy Jr., CPA, PC

We at John F. Dennehy CPA are a team of certified public accountants who service clients throughout Long Island. The services that we provide are comprehensive, and we can resolve multiple accounting needs for a client.

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