5 New Ways to Increase Your Chance of Being Audited by the IRS

August 24, 2019  | By Erik Lincoln

What?! Of course you don’t want to increase your chance of being audited by the IRS.  But, maybe by understanding what increases your chances, you can better avoid an audit.

Many people are aware of at least a few common IRS audit triggers, such as reporting information on your tax return that is different from a tax statement you received (e.g., W-2, 1099, K-1s, etc…).  If this happens, you will at a minimum receive a letter from the IRS asking you to explain the difference or correct it. Another widely known trigger is claiming unusually high expenses compared to similarly situated taxpayers.

In addition to the above audit triggers, the IRS, through its Large Business and International division, published a list of 52 issues they are currently pursuing.  Many apply to large businesses and international tax matters.  However, listed below are a few that apply to a wider audience.

1.  Virtual Currency – In 2016, only 802 individual tax returns out of the 132 million filed electronically reported income related to cryptocurrencies. As a result of the low number of filers reporting virtual currency transactions, the IRS added the issue to its list of issues to target.

What do taxpayers need to report in connection with their virtual currency transactions? Virtual currencies are treated like any other investment property? Like stocks or bonds, any gain or loss from the sale or exchange of the asset is taxed as a capital gain or loss. Similarly, if you use cryptocurrency to buy something (goods or services), you are required to report the increase in value (from the time you acquired the currency to the time you used it) as taxable gain.

2.  S Corporation Distributions, Losses in Excess of Basis, and Built in Gains Tax – The IRS has three separate campaigns for S Corporations as follows: distributions that may be taxable, losses claimed in excess of basis, and situations that trigger the Built in Gains tax. These issues are technical in nature and beyond the scope of this article. But, if you own an S corporation, make sure you work with a CPA well versed in S corporation rules.

3.  SECA Tax – Partners in a partnership report income passed through from their partnerships (including LLCs treated as partnerships). Unless an individual partner qualifies as a “limited partner” for self-employment tax purposes, the partner’s distributive share is subject to self-employment tax under the Self-Employment Contributions Act (SECA).   The IRS believes that some individual partners have inappropriately claimed to qualify as “limited partners” not subject to SECA tax.

4.  Inbound Distributor – U.S. distributors of goods sourced from foreign-related parties that have incurred losses or small profits on U.S. returns may trigger an audit. The amount of income reported by a U.S. distributor must be commensurate with the functions performed and risks assumed.  The IRS believes that in many cases, the U.S. taxpayer has not received the appropriate amount of profit (i.e., which is generally the amount they would have received in an unrelated transaction).

5.  Economic Development Incentives – Some taxpayers (e.g., start-ups) receive a variety of government economic incentives.  The IRS believes some of these taxpayers may improperly treat government incentives on their return, such as cash grants, by excluding them from gross income and also claiming a tax deduction when using the grant to pay for an expense.

Erik Lincoln is a founding member of Lincoln. In addition to being an attorney he is also a CPA. Erik has consistently been recognized as one of the top attorneys in North Carolina, by Business North Carolina.