As a tax attorney, I can think of no other than these two words that invoke fear in the hearts of people: IRS audit. After all, nobody wants to receive a letter from the Internal Revenue Service (IRS) stating their tax returns and financial matters are being investigated. I receive so many questions from San Francisco business owners and tax payers asking what are the common triggers of IRS audits in California. Here’s a look at the red flags in tax returns and other common scenarios that cause IRS audits.
Failing to Report Income – Not reporting all your income is a big red flag to the IRS. This is not just income you received and paid taxes on, which would likely have been sent to you as a W-2. This also includes 1099 income earned as an independent contractor. Every bit of income you receive that’s reported on a Form 1099 must be reported on your tax return. You also need to report income received from brokerage accounts, rental property and distributions from a college savings account to pay tuition.
Large Numbers of Questionable Deductions – A big trigger for an IRS audit is the reporting of several itemized deductions on a tax return, especially for independent contractors. For example, claiming $7,000 in charitable donations when you only make $30,000 may raise a red flag with the IRS. Auditors also look for expenses that are a bit out of the ordinary, such as excessive meals that are deemed an expense, or travel that may include more than business. Other audit triggers, especially for individuals who are self-employed, are claiming a home office or the business use of a vehicle. Hobby-related deductions, or when a taxpayer is deducting expenses they spent on a hobby and not one that earns income, is also a strong audit trigger.
Earnings in Excess of $200,000 on a Schedule C — The IRS generally likes to audit those that make a substantial amount of income. If you’re an individual that makes more than $200,000, that can set off a red flag and your chance of being audited increases.
The Earned Income Tax Credit – The Earned Income Tax Credit (EITC) is a benefit for working people with low to moderate-income. The EITC reduces the amount of tax you owe and may give you a refund, and increases with the number of children dependents you claim on your tax return. Claiming the EITC is an automatic trigger for an audit because you must qualify for the credit under certain requirements. If those requirements are not met, you will get a notice of an audit.
IRS Computer Score – Sometimes it’s not one thing you report on your tax return. But instead, your return is flagged as part of the IRS’ computer system that every tax return is run through. The system is designed to detect anomalies in tax returns and compares the returns against other similar ones. Some of the things the system looks for are duplicate information reported, such as two people reporting the same deduction or credit. For example, two parents both report their child as a dependent on their return. The computer system picks up on these discrepancies and will flag the return for a potential audit.
Amended Returns – An amended return often serves as a red flag to the IRS, especially when taxpayers try to amend their return from a prior year as quickly as possible. The amended return may set off a trigger to the IRS to consider your return for audit purposes.
IRS audits can be a scary prospect, especially when you don’t know what the IRS is looking for when they start the process. Working with an experienced tax professional or attorney can save your San Francisco business time and money. That individual can also review your business expenses and returns to make sure there are no red flags that may trigger an IRS audit in California.
Allison Soares is a partner and tax attorney at Vanst Law LLP. It doesn’t matter the issue: audits, collections, appeals, international disclosures, grumpy people— Allison enjoys fixing problems. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits from San Francisco to San Diego.
