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LUQ: Large, Unusual, Questionable: Your Bank Records

What the IRS Does With Your Bank Records: Tax Audit Report #3

A third step often involved in the review of your bank records during your tax audit is for the IRS audit to proceed with a review of your monthly bank statements. The monthly bank statements are studied to:

1. Help understand the frequency and normal amounts of deposits.
2. Determine the average amount and number of checks written.
3. Observe the interaction between accounts.
4. Compare the total deposits to the gross income of the taxpayer by considering non-taxable deposit sources such as loans, checks to cash, transfers between accounts, gifts and inheritances, and insurance proceeds and by identifying large, unusual, questionable (LUQ) deposits and withdrawals which warrant further audit action. Keep in mind that this is not a bank deposit indirect method of determining income, which is only appropriate for cash method taxpayers or taxpayers who have inadequate books and records.
5. Trace these LUQ items through the ledger to determine their source and book treatment.
6. Interview the appropriate person to determine the treatment of LUQ items.

What does this mean for you when you’re undergoing an IRS audit of your monthly bank statements? Essentially the IRS is looking for LUQ’s – Large Unusual Questionable deposits and withdrawals. For example, your monthly paycheck deposits might total $4,000. Then one month you show a deposit of $15,000. You can bet the IRS auditor is going to want to know the source of this large amount. In IRS terminology it is known as a LUQ. A LUQ is an IRS tax audit flag. You will be asked where the money came from and where it went. You will usually explain that the $15,000 is a settlement from your auto accident, or that your dear Aunt Daisy left the money to you in her will, or that your father gave you the money to help you go back to grad school and so forth. You should always keep a copy of the check or money order, therefore, that the deposit came from. Armed with this evidence you can easily show the IRS auditor that the LUQ is not income. Showing that a deposit is not income is the bottom line for you; if an item is not income, then it’s not taxable. Problem solved.

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