AUDIT FLAGS
Important IRS Audit Issue and Red Flags
INDIVIDUAL & S CORPORATION
INDIVIDUAL TAX RETURN FORM 1040 AUDIT FLAGS
Income & Expenses Not in Balance:
  1. On your income tax return total income is less than your deductions, especially itemized deductions on Schedule A, this is the radar area creating automatic questions and possible examination.  This is a red flag for the standard of living that does not match the lifestyle. This could trigger other audit questions on the individual return and could relate to your pass-through income or loss such as K-1.
Schedule A- Acquisition Mortgage and Home Equity Loans TCJA: 
  1. Home mortgage interest. You can deduct home mortgage interest deduction (HMID) on the first $750,000 ($375,000 if married filing separately) of indebtedness. However, higher limitations ($1 million ($500,000 if married filing separately)) apply if you are deducting mortgage interest from indebtedness incurred before December 16, 2017 Currently, HMID allows itemizing homeowners to deduct mortgage interest paid on up to $750,000 worth of principal, on either their first or second residence. This limitation was introduced by the Tax Cuts and Jobs Act (TCJA) and will revert to $1 million after 2025. Generally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home) The limit on the principal home acquisition loan was 1,000,000 and 100,000 for the home equity loan before the new TCJA Under the provision, a taxpayer may continue to claim an itemized deduction for interest on acquisition indebtedness. If you are deducting more than the above limits, then creating red flags. The amount above these limits must be calculated to reflect accurate proportion of mortgage and equity interest on the Schedule A.
Form 1098 Mortgage Interest Report – A major red flag and future audit issue
  1. with matching the new information of on Form 1098. These new items on the boxes are-Box 2: Outstanding mortgage principal as of 1/1/2019 Box 3: Mortgage origination date Box 5: Mortgage Insurance Premiums Box 7, 8, 9: Address information of property securing the mortgage. If the amount of loan has exceeded the acquisition loan amount which will limits the mortgage interest deductions for the taxpayer. If loan refinanced it can also qualify as acquisition loan or debt, if it does not exceed the amount of the old acquisition loan just before the refinancing.
Charitable Deductions: 
  1. Higher than average charitable deductions relative to the income level could create red flags. Make sure that the charity organization is recognized by the IRS and have a valid non-profit organizational status. Make sure to receive receipt when giving cash donation the cancelled check by itself is not enough. Take picture of non-cash items donating. On the non-cash donations extreme caution should be used. What the charity organization provides to you most of times is not the real fair market value of the donated item. Keep supporting records of donated items.
Schedule C: 
  1. While overall risk of an individual tax audit is low; the odds go up when you file a business tax return or Schedule C.  Especially home Office Deductions, IRS allows home office deductions, but they have to be reasonable and not overstated expenses. Unreasonable percentage of deductions for home use of business such as utilities, mortgage interest, property tax, or rent causes red flag. Home office use has to meet the rules of IRS exclusive use test such as a use in a regular basis as the principal trade place of business or for the meeting the customers or clients
  2. 100% use of auto expense in business also creates red flags.  The percentage use of auto has to be reasonable percentage between business and personal use either actual expenses such as gas, repairs, insurance, deprecation, or when the auto is leased for business.  Auto mileage is a basis for the percentage of business and personal usage, keep log if possible.
  3. Below average net income also creates questions and red flags.  Based on government collections there are some averages for each industry in professional services or retails or wholesales or others.
  4. Continues losses in business three out of five years.  From government point of view, you are there to make money and profit motive is the basis of business.  If it is a hobby, then it is not belonging to schedule C and it has to be treated in different schedule as hobby activity rules and not business motive.  Hobby losses are limited to the extent of income and not more that income.
  5. A mismatch of 1099 income by third party to IRS and what you have in your recordsends up a red flag and causes the IRS computers to spit out a bill. If you have received1099 that is not correct immediately inform the sender to void and send a new one.
Stock Market Activities
  1. The brokerage firms report the gross proceeds and the cost basis to IRS through them atching concept from third party government would know the stock activities.  Make sure to keep accurate stock market activities and provide them to your tax preparer that you will receive by end of each January for the previous year activities.  Be aware of wash sales many ignore them and be surprised when income tax returns prepared at the end of year and loss the wash sales portion as deduction. Exceptional rules for day traders.
Passive Activities Reporting:
  1. If you have rental properties this is a passive activity.  The loss is limited to maximum of $25,000 if your adjusted gross income below $150,000.  It will phase out up to$150,000 of income.  If you are an active participant in this property.  If you are material participant and a real estate professional with certain amount of time during the year spend in real estate activates then your loss is not limited to $25,000.  There are certain rules that have to be met. The above information is for the educational and general informational purposes only.  These are not tax or legal advises.  For any specific matters you have to consult with your tax, legal, and financial adviser.
S Corporation Reasonable Salary Compensation of Officer
  1. IRS is auditing S corporations for not having a reasonable amount of compensation for the officers and active shareholders. The reason is that with the pass-through income from K-1 to the shareholder income no self-employed tax is paid on the ordinary income. Self-employed tax(social security rate 6.2% or $8,239.80 for employer and 6.2% or $8,239.80 for employee for the maximum amount of maximum $132,900 for year 2019) the Medicare rate of 2.9% remains the same with no limit which 1.45% is for employer and 1.45% for employee.

Please take this tax issue very serious since there is some time before the year-end now. If you have someone doing your payroll service contacts with them and if you are not sure about the reasonableness of amount call me to help you soon and do not delay. If you do not take any reasonable salary, then all the distribution and net earnings will be subject to self-employed tax for salary purposes. Under TCJA the reasonable considered 70% of your net as salary.

Summary of Red Flags Inviting Audit on Income Tax Returns
  • LARGE HOME OFFICE DEDUCTION CLAIM
  • GIVING UNPROPORTIONATE MONEY TO CHARITY RELATIVE TO INCOME.
  • CLAIMING DAY-TRADING LOSSES ON SCHEDULE C-IF NOT REAL DAY TRADER.
  • DEDUCTING LARGER THAN USUAL BUSINESS MEALS & ENTERTAINMENT AND TRAVEL EXPENSE.
  • CALCIMINING LARGER RENTAL LOSSES RELATIVE TO RENTAL INCOME.
  • CLAIMING 100% BUSINESS USE OF VEHICLE RATHER THAN BUSINESS USE PORTION.
  • HIRING TAX PREPARER WHO FALSIFIES YOUR RETURN FOR LARGER REFUND WITHOUT SUPPORT.
  • WRITING OFF A LOSS FOR A HOBBY NOT A REAL BUSINESS ACTIVITY.
  • NOT REPORTING A FOREIGN BANK ACCOUNT OR OTHER FINANCIAL ACTIVITIES.
  • YOU USE DIGITAL CURRENCIES, CRYPTOCURRENCY AND NOT REPORTING.
  • AMENDING TAX RETURNS AND OPENING A NEW STATUTE OF LIMITATIONS FOR AUDIT.
  • MISSING OR NOT REPORTING TAXABLE INCOME ON TAX RETURNS-W-2, 1099, 1099K, K-1, SALES OF ASSETS,SALES OF STOCKS,