IRS Audit Red Flags

Ms. Greta P. Hicks CPA
June 20, 2013 — 2,748 views  
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Mark W. Everson, IRS Commissioner, has stated: “The President’s 2008 budget request for the IRS, together with the accompanying legislative proposals concerning tax administration, is welcome. They will do much to promote compliance with our tax law…” Compliance is the key word and in plain language, compliance means additional audits and more aggressive IRS collection agents.

Beginning in 2008, the IRS will begin another National Research Program on Form 1040 returns. According to the IRS, this enforcement initiative will collect “compliance data for new segments of taxpayers needed to update existing estimates of reporting compliance. Unlike the past, the IRS will conduct an annual study of compliance among 1040 filers based on a smaller sample size than the 2001 National Research Program study.”

Another focus for the 2008 fiscal year is the enforcement initiative that “will address and improve compliance among small business and self-employed taxpayers in the element of reporting, filing and payment compliance by increasing audits of high risk tax returns, collecting unpaid taxes from filed and unfiled tax returns, and investigating and, where appropriate, prosecuting persons who have evaded taxes.”

A new Automated Substitute for Return (AUR) site within the existing IRS space in Kansas City will address the mis-reporting of income by individual taxpayers. Recently, the IRS has been sending out notices of non-filed returns for tax years 2000 and 2001, as well as more current years. The IRS is also making greater use of the AUR Refund Hold Program, which “minimizes revenue loss by holding the current-year refunds of taxpayers who are delinquent in filing individual income tax returns and are expected to owe additional taxes.”

How does the IRS determine who to audit or what items on a tax return will “flag” a particular return? A list of items that most certainly raise a red flag includes:

  • Unreported or Forms 1099 and W-2 do not match Form 1040;
  • Amended returns and claims;
  • Request for examination reconsideration;
  • Offers in compromise – doubt as to liability;
  • Innocent spouse requests;
  • Social Security number mismatch;
  • Math errors;
  • Frivolous filer program;
  • Joint committee tentative carry-back allowances; and
  • Prior year notice of inadequate records.

“High risk” items that may raise a red flag and initiate an IRS audit include:

  • High miscellaneous itemized deductions;
  • High-income non-fliers;
  • Non-cash charitable contributions;
  • High-income taxpayers;
  • High business auto use;
  • Large, unusual or questionable items;
  • High entertainment and/or travel expenses;
  • High legal fees, especially on Schedule A;
  • Form 8300, reporting cash payments over $10,000; and
  • Transaction Report (CTR) or Suspicious Activity Report (SAR).

What amount does the IRS consider “high?” High is relative. For example, $10,000 could be high on one taxpayer’s return, but low on a different taxpayer’s return; high is based on the amount as it relates to the income reported on the return. So how high does it have to be before it is too high? There is no answer to that question except to use your own experience and make a judgment call.

Can you ask why the return is being audited? Yes! The agent/examiner does know why the return was selected and can even tell you what items on the return the classifier (the person who selected the return) decided was most questionable. The agent/examiner may say, “Your number just came up.” That’s a valid answer, because the computer does select returns based on a scoring system. Most returns are selected by computer, but many are not. If you receive a vague answer, ask your question in a different manner or ask to talk to the manager.

How can you avoid or limit red flags?

  1. During the preparation phase, make sure to double check and question the client repeatedly regarding all outstanding W-2 and 1099 forms. If you receive a Form 1099 that is not the client’s, put it on the return, back it out and explain why the item is not income to this taxpayer.
  2. If the client receives the wrong Form 1099, put the information on the line that a layperson would expect to find that particular 1099, and reverse it with an explanation. For example, the client received a 109-MISC, but it should have been a 1099-INT.
  3. Double, triple and quadruple check Social Security numbers, not only of children, but also of spouses. Check the spelling of names. If in doubt, as the client for a copy of the Social Security card.
  4. Make sure the math adds up. For example, reprint the whole return and not just the pages corrected; otherwise, you could have a Schedule C of one amount and Line 12 of Form 1040 may be a different amount. No, I’m not joking—it has happened.

Compliance, which equates to more audits, is the IRS focus for this year and in coming years. The IRS has hired and is training additional agents/examiners. They’re back in the business of doing audits.

If you have any questions about your responsibilities for preparation of returns or for representing clients during an IRS audit, consult the most recent version of Circular 230. You can also go to AICPA’s Web site at and review the Statement of Practices for Tax Services section.

Ms. Greta P. Hicks CPA

Greta P Hicks CPA