IRS Tax Audit CPA gives Tax Audit Prevention Advice | IRS Red Flags

Most tax audit CPAs agree prevention is usually better than an audit. I say usually, because on some tax positions, you almost have to let the IRS audit you. I expand my scope as an IRS tax audit CPA to include being proactive about audit prevention. Tax audit prevention doesn’t mean rolling over for the IRS. Here I’ll cover some basic tips that affect all types of tax returns; personal, business, Corporate, payroll etc.

“Some tax audits are inevitable. But being aware the following issues should cut your odds.” 
- Gary Bode, tax audit CPA

Tax Audit Red Flags from items not present on your Tax Return (but should be)

Let’s look at a real situation:

• Say you have rental property and File Schedule E or Form 8825.
• You have a mortgage on the rental property.
• The IRS gets a copy of Form 1098 from your lender, at the end of the calendar year, stating the mortgage interest received for the year.
• Imagine this deductible interest is left off Form 8825 or Schedule E.
• Believe it or not, the IRS picks up this missing deduction (by cross correlating it with Form 1098), corrects your return, and sends you a refund.

Look at it from an IRS tax audit perspective. If the tax preparer is careless enough to omit an obvious deduction, what other mistakes might there be?

Explain Unusual Items on your Tax Return

Most unusual transactions on tax returns are perfectly valid. But as a tax audit CPA, I recommend explaining the circumstances of the unusual items. Sometimes I include corroborating documents as well. I try to imagine a skeptical IRS agent looking at your tax return once it’s kicked out of the system for hand processing. What will they look for? Well, on returns prepared by CPAs, there’s a clear, concise explanation which probably prevents any further IRS attention to your return, at least on the main issue.

Here’s an example:

• Taxpayer X earns $40,000 in annual wages.
• Taxpayer X usually contributes $6,000 to charity per year.
• But this year, Taxpayer X contributed $16,000 to charity, despite earning the same $40,000 of wages.
• The $10,000 additional charitable contribution, on this year’s tax return compared to prior tax returns, is an IRS red flag.
• Taxpayer X received $10,000 as a gift from a Cousin.
• The $10,000 gift incurs no IRS obligation for Taxpayer X or the Cousin. So there’s no reason not to offer an explanation.
• A tax audit CPA would include an explanation explaining the gift from the Cousin.
• A tax audit CPA would list each charitable organization on Schedule A; we wouldn’t just use the lump sum of $16,000.
• Some tax audit CPAs would include copies of the receipts as well.

Include all Tax Information on the Return

In my experience, a tax audit CPA is  most often consulted because some piece of income related data is missing from a tax return. Lately this documentation tends to be Form 1099-C, Cancellation of Debt, and Form 1099-S, associated with short sales on investment property. Form 1099-C reports debt cancelled by the lender. Cancelled debt becomes taxable income unless your CPA can exclude it on Form 982. Form 1099-S reports the sales price of the short sale. Both forms come with an IRS expectation of taxes due. The IRS believes $200 Billion of income goes unreported.

Here’s an Example

• Two and half years after submitting an original return, a Client got a nice IRS notice demanding $190,000+.
• Why? The IRS got a Form 1099-S for that tax year on a real estate sale of $600,000+.
• Of course the IRS had no information on the original purchase price of the property.
• So they wanted $190,000 of past due tax, penalties and interest.
• Naturally, because of the recession and housing market bubble, she lost money on the sale.
• Why didn’t she report the sale in the first place, especially since it wasn’t taxable?
• I don’t know. But it’s apparent to me that sometimes lenders don’t get a copy of Form 1099-s or Form 1099-C to the taxpayer.

“Be proactive on your tax return. If you expect a tax document, and it doesn’t arrive, call and get a copy.”
- Gary Bode, tax audit CPA

Be Quick to Amend your Tax Return Once You’re aware of a Mistake

There are lots of good reasons to amend a prior tax return. I doubt most amended returns raise an eyebrow by the IRS. I think amending a tax return before the IRS sends a Notice helps prevent an audit. But be careful not to open a can of worms. Review your original return to check for other issues. Check to see if the same error occurred on earlier and subsequent tax returns.

Don’t use Estimates on Tax Returns

I think round numbers on an IRS tax return look like estimates instead of being based on actual financial activity. The IRS doesn’t like estimates. For example, if the IRS audits your business mileage and decides the figure is estimated, they can deny any business mileage deduction. Even though there was some business mileage.

“In my experience, folks who estimate tax figures generally under-estimate. Strange but true.”
- Gary Bode, tax audit CPA

Other Tips:

• Don’t send a hand written return.
• Use tax software.
• Don’t make math errors.
• Check your current tax returns against the two previous returns. Remember the IRS checks your return for accuracy within the current return, against your prior returns, and other tax returns the IRS deems comparable.
• Stay aware of sensitive IRS issues. They publish topics they’re currently interested in. Why? I think they prefer accurate returns to tax audits.

I’m an IRS tax audit CPA with a virtual office to serve you regardless of your location. I believe my responsibilities include proactive tax return preparation to avoid tax audits. No CPA can guarantee your return won’t be audited of course. For a free phone consult please call (910) 399-2705.