IRS Targets Red Flag Issues

The IRS only has the time and budget for “a few good audits.”

Budget cuts have made the IRS relook the discipline of working smarter. Knowing how to identify and select a “few good audits” has become the fine art of data management as the IRS targets red flag issues which often create errors, misrepresentation and confusion.

Does your tax return have red flags?

Probably. If it does, the IRS might consider your return as being a candidate for their list of “a few good audits.” These audits require less work on their part to potentially bring in more revenue through higher taxes and interest-generating penalties. Their decision might have looked good to them at first; after all, red flags were there. But if your return is clean, correct, documented and signed by a CPA, your audit could quickly become a waste of their valuable time and budget allotment. In fact, you might not even know they gave it a second look.

In no particular order, here are some red flag issues the IRS targets:

• Claiming a lot less money than last year. The IRS pays attention. Actually, they track historic data and a noticeable change in this number could catch their eye.
• You make lots of money. For 2015, filers making less than $200,000 made up a group in which only one out of 132 were audited. Over $200,000 upped the number to one out of every 38 returns. Over a million? One out of ten.
• Taking an alimony deduction. If paid in cash or check, alimony is generally deductible by the payer and taxable to the recipient. Also, alimony doesn’t include child support or non-cash property settlements. The rules are complicated. The IRS targets confusion. Add a mismatch in numbers by ex-spouses, and the IRS sees a profitable audit.
• Very charitable deductions. The IRS knows the average for your area and income level. If you claim non-cash donations and fail to include Form 8283, they tend to notice. Part of the IRS’s ‘work smarter’ plan helped them figure out that anything a tax filer doesn’t have to substantiate when filing is more likely to be fudged.
• Filing an estate tax return. There aren’t many of these filed; only 35,619 in 2016 with approximately 7.8% receiving extra attention by the IRS. More than 16% of estate returns with assets between $5 and $10 million were examined. One out of three returns with assets exceeding $10 million were audited. These are returns you don’t want to tackle without your CPA tax specialist. Yes, we do these.
• Taking an early payout from an IRA or 401(k) account. The IRS is paying special attention to payouts before age 59½. Unless an exception applies, these payouts are subject to a 10% penalty on top of the regular income tax. An IRS sampling found that nearly 40% of individuals scrutinized made errors on their returns relative to retirement payouts. Most mistakes came from taxpayers who didn’t qualify for an exception to the 10% additional tax on early distributions. This is a serious red flag the IRS targets.

What’s the best way to handle red flags?

Let’s review your red flag issues, look for potential problems, and make adjustments before the end of the year. If your return is timely, clean, correct, documented and signed by a CPA, the IRS will most likely view your red flags as being neatly folded and boring.

Now what?

Here’s some basic advice from singer Jim Croce’s lyrics:

• You don’t tug on superman’s cape
• You don’t spit into the wind
• You don’t pull the mask off that old lone ranger
• And you don’t mess around with Jim

Just change that last line to, “And you don’t mess around with the IRS”

What’s the bottom line?

If you have questions or aren’t sure you have all the answers you need to keep from waving your red flags, contact us. We know taxes.

The IRS says this about Understanding your IRS Notice or Letter

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