Red Flag Tax Audit

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What is a Red Flag Tax Audit?

In recent years, less than 2% of all individual income tax returns have been audited. However, your chances for an IRS audit are higher depending upon certain types of income, certain amounts of income, your profession, the types of transactions, and the types of tax deductions claimed on your tax return. Returns selected for tax audit always reflect these tax audit flags. The IRS does not have enough personnel and resources to examine every tax return, so the IRS selects those tax returns which, upon quick review, have high audit potential – those that are most likely to result in a substantial tax audit deficiency.

Your chances of being the subject of an IRS tax audit are greater when the following are present:

  • You are a shareholder or partner in an audited partnership or corporation.
  • You claim substantial cash contributions to charities that are disproportionate to your income.
  • An informant has given information to the IRS (think angry ex-spouse or business partner).
  • You claim tax shelter investment losses on your tax return. This is a juicy tax audit subject.
  • You have complex investment or business expenses on your tax return.
  • You have large amounts of itemized deductions on your tax return that are outside IRS audit parameters.
  • You own or work in a business which receives cash in the ordinary course of business. Lawyers beware.
  • Your business expenses are high in relation to your income.
  • You have rental expenses on your tax return.
  • A previous IRS audit resulted in a tax deficiency.
  • You have complex tax transactions without explanations on your tax return.

You must report all your income, and you should take all your tax deductions, even if they increase your chances for an IRS audit. Don’t be scared off by these factors. However, also realize that your chances for an IRS audit do increase with certain tax items, and prepare your tax return accurately and completely. Don’t use a cheap “tax return mill” for this kind of return.

High Wages

As your income goes up, so does your chance of an IRS audit. Based on audits of 2002 tax returns, the odds of an IRS audit for someone in the $25,000 to $100,000 income bracket are 1%. For those making more than $100,000, the odds increase to almost 2%, or double.

Large Amounts of Itemized Tax Deductions

If your itemized tax deductions on your tax return exceed certain parameters set by the IRS, the chances of being audited by the IRS increase. This does not mean that you should not take tax deductions on your tax return that you are entitled to, but you should realize that your chances for an audit increase if your tax deductions exceed the averages for your income level.

High DIF

When your tax return is filed, IRS computers compare it against the national Discriminate Information Function (DIF) system average. The IRS calculates the DIF score by using a closely-guarded formula. Tax returns with the highest DIF scores are scrutinized by IRS tax audit experts who decide which tax returns provide the best chance for collecting additional taxes, interest, and tax penalties.

Unreported Taxable Income

Unreported taxable income is a common red flag. Who, you might ask, wouldn’t report all their income? After all, it’s a simple matter in a tax audit for the IRS tax auditor to add up all your bank deposits for the year and compare that to the income on your tax return. Simple, yes, but sometimes the omission of income is purely accidental. In the tax audits we handle we see innocent omissions again and again. Also, the IRS discovers unreported taxable income when its computers match the taxable income you reported on your tax return with information gathered from stock brokerages and others. For example, if you failed to report on your tax return the gain earned on a sale of stock, the IRS typically will catch you when it matches the stock broker’s payment records, called 1099 forms, against your tax return.

One good way to make sure you don’t miss unreported taxable income is to review last year’s tax return to make sure you have 1099′s, etc. from mutual funds, banks and other sources.

Self Employment

Because the IRS believes most under-reporting of taxable income and abuse of tax deductions occurs among those who are self employed, these individuals are audited by the IRS far more frequently than employees collecting a salary. There’s a high incidence of tax audit for taxicab drivers, saloon owners, waiters and waitresses, and others who traditionally receive payment in cash. Also, the IRS will sometimes conduct tax audits of certain individuals to determine if a taxpayer’s reported taxable income can support his or her lifestyle.

Home Office Tax Deductions

We see home office tax deductions selected over and over by the IRS. You could almost say the IRS has a huge dislike of this deduction. Since the tax rules for deducting home office expenses on your tax return are complicated, you should consult us at IRS-SOLV to determine whether you qualify to deduct home office expenses on your tax return.

Unreported Alimony

Over the years, the IRS has found that not all taxpayers report alimony received as taxable income. Because of this, the IRS now matches tax deductions for alimony payments by one former spouse with the taxable alimony income reported by the other.

Automobile Logs

One of the biggest and most commonly audited items by the IRS for individuals in their own business, and employees of companies who use their car in business, is the tax deduction for business transportation. It is important that you keep good records of all tax deductible automobile expenses and a mileage log showing business miles driven. If you haven’t kept such a log we can help reconstruct one from your appointment book and software we recommend (less than $30 to buy).

What Do I Do If I’ve Been Audited?

There is good news. Firstly, by retaining our law firm, you gain the power and expertise of tax lawyers who know how to deal with Revenue Agents and IRS tax audits. For openers, once our firm is hired by you, the assigned Revenue Agent or Revenue Officer must deal directly with our firm, instead of with you. This keeps you much safer in the tax audit than trying to deal with the IRS by yourself and risk saying something that might make things much worse for you. Let our knowledge and professional stature take over for you and stand firm on your behalf.

Your entire tax audit case is handled by me-this is my secret. I handle every aspect of a tax audit myself. Every phone call is made by me; every letter is drafted by me; every meeting or dealing with the government is done only by me. I believe there is no such thing as a routine tax audit, or call or letter to the government. They all mean something and nothing should be overlooked or taken for granted. There are no salesmen or assistants working on your confidential tax audit case at any time. Of course, I also rely on the valuable assistance of a select group of CPA’s and professionals to help me develop your IRS audit case. But when it’s all said and done, it is my opinion and my expertise that will be presented to the IRS and Tax Court judges. Please compare this level of tax audit service and applied expertise to that offered by others. You will be amazed at what a difference this extra protection and care can make in the outcome of your tax audit. Our typical clients are individuals, small businesses and professional people, and small-cap corporations who require the assistance of outside counsel at some time during their tax audit. They are looking for serious tax audit help and they soon find John Ellsworth has their IRS audit answers.

I am a tax audit lawyer with 37 years of experience. My tax audit law practice extends across the United States. Each year I take tax audit cases from all states and overseas. I also practice defense of criminal tax cases. I try cases in U.S. Tax Court and U.S. District Court.

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