10 IRS Red Flags

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Clients always ask, is this going to result in me getting audited? The truth is that we never really know. Some audits are randomly generated, some are more likely based on income or entity structure, and some are based on the areas that the IRS knows are traditionally not handled correctly or documented well.

If you want to reduce the likelihood of your clients being audited, or even just receiving notices that will result in you have having to spend more time on returns, then make sure you handle these 10 red flags with extra care.

  1. Not reporting all your income – this seems like a no brainer to practitioners, but we’ve all had the client who frustratingly ends up with a 1099 or K-1 that pops up even after we’ve drafted the return. Checklists and reminder lists can help your clients to double check what forms they need to be sending to you before filing.
  2. Taking business deductions that seem too big – computerized review has aided the IRS on this one. Business returns are reviewed by NAICS code for common percentages and averages. I once had a photography client get audited because she claimed $0 in cash sales outside of her 1099-K from her credit card processor. Her contracts all clearly stated that fees had to be paid electronically in advance of sessions, but it made her return look unusual compared to her industry.
  3. Writing off hobby losses year after year – this one has been hot since COVID. The gig economy uptick has everyone starting a side hustle and few people claiming all their income, or even properly claiming their expenses, from their side hustles. Make sure you’re talking to your clients about hobby loss rules and what constitutes a sustainable business that isn’t going to result in them owing back taxes to the IRS.
  4. Claiming the American Opportunity Tax Credit incorrectly - The IRS checks closely to make sure people take this college tuition credit properly. Be sure to ask your clients enough questions to ascertain what they actually qualify for.
  5. Health insurance credits that don’t match 1095-A - The marketplace websites estimate credits to help pay premiums but not everyone’s income actually ends up falling in line with those estimates. Over/under payments of premium credits are reconciled when taxpayers file their returns, and failure to properly report form 1095-A will always result in a notice and could also boost your client’s chances of an audit.
  6. Taking retirement money out early without the penalty – If your client had a legitimate reason to not be subject to penalties, make sure that the brokerage firm properly reports that on the 1099-R with the correct codes. Otherwise, you can expect an adjustment notice.
  7. Not reporting gambling winnings or claiming huge gambling losses – I recommend that this one stay on your annual tax organizers/questionnaires. Clients often don’t think about gambling winnings until a 1099 that they weren’t expecting pops up. Claiming huge gambling losses is another red flag. Make sure your client’s losses are backed up by proper documentation.
  8. Improperly claiming rental real estate losses – Not all tax software does this correctly so double check to ensure your clients are actually claiming rental losses properly as passive or non-passive income. Only rental real estate professionals can claim rental losses as non-passive and use it to offset their ordinary income. Don’t assume your software is doing this correctly.
  9. Falsely claiming the research & development credit – Much like the ERTC credits that were wrought with fraud and “expert” firms popping up all over the country claiming to help clients receive huge refunds, the IRS is cracking down on firms that solicit clients to claim research and development credits. Make sure your clients work with a reputable expert if they choose to go this route and review the documentation to support the credit calculations.
  10. Not reporting virtual currency transactions - The IRS hunts for unreported income from buying, selling or trading bitcoin and other digital currencies. They expect you to report it even if you just made a little money. Most clients don’t know that even transactions like coin splits and gifts are reportable income and failing to add it to their returns could raise questions. If your clients are invested in digital currency, make sure you have a conversation about what their transactions looked like.

Christine Gervais

Christine Gervais is a licensed CPA, using her skills to help businesses grow and achieve their fullest potential. Christine has a Master’s degree in accounting from Southern New Hampshire University in addition to holding her CPA license for over a decade. Notably, Christine is a nationally recognized speaker providing education to other CPAs on how to best serve clients as well as instruction on a wide variety of topics for business owners on how to maximize success. Christine prides herself on the value she can bring to clients with her extensive tax knowledge and providing strategic, forward-thinking financial strategies to help clients grow. When not behind her desk, you can find Christine spending quality time with her daughter and stepson or tending to the family’s excessively loved farm animals.