Sam Brotman, JD, LLM, MBA September 29, 2013 6 min read

IRS Audit Red Flags – Part Four – Cash

Continued from IRS Audit Red Flags – Part Three – Frequent IRS Targets

Cash is a major audit red flag because it creates all sorts of problems for the IRS. It is almost impossible to track cash transactions, can be easily hidden, does not have a clear electronic record to keep track of it, and is difficult for the IRS to verify. One of the big fights that the IRS has been waging for years has been against cash businesses. Hospitality workers who do not report their tips, taxi drivers who collect off-meter fares, retail store owners who sell merchandise off-book, etc…Cash transactions go unreported by a great many taxpayers, many of whom believe that they do not have the report the cash (wrong) or who figure that the IRS will never know that the taxpayer received cash. Specifically, the IRS targets returns where taxpayers may deal with large amounts of cash and consider it an audit red flag when a return contains a high probability of unreported income. The IRS does this by looking for these three methods of fraud:

Skimming – taking cash from a business prior to it being recorded as a sale. For example, a clerk in a store who does not ring up a transaction and pockets the cash.

Embezzlement – taking cash after a sale has been recorded. For example, a clerk in a store who takes money out of the cash register.

Fraudulent Transfers – A transfer of funds listed as an expense when it actually should be recorded as income. For example, a payment listed as being to a vendor that is actually taken by an owner or employee.

These examples illustrate methods that taxpayers who deal with lots of cash use to cheat the IRS and provides you with a rough idea for the types of things the IRS is looking for when they audit a cash return. As a result, taxpayers who frequently deal in cash will likely receive increased scrutiny by the IRS. This audit red flag is raised when the IRS identifies these taxpayers by looking at the occupation code that they indicated when they filed their tax return or what the taxpayer lists as their occupation on page 2 of the tax return. Those returns that have a high likelihood of unreported income or fraud will likely then be subject to audit.

Also, of note, that another audit red flag related to cash (and one that the IRS has been targeting) is those taxpayers who make cash transactions in excess of ten thousand dollars. Banks and other financial institutions are required to fill out currency transaction reports (CTRs) when an individual pays, deposits, or otherwise utilizes over then thousand in cash. In addition, those who deposit lesser amounts to try and avoid the CTR (which is called structuring and is illegal) or who otherwise participate in a suspicious activity risk having a suspicious activity report (SFR) filed against them. It is not clear how exactly these items affect a person’s audit risk. However, it is clear that these documents are reported to and kept track of by the IRS.

Continue to IRS Audit Red Flags – Part Five – Schedule A and E

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Article Index

IRS Audit Red Flags – Part One – Why IRS Audits Occur

IRS Audit Red Flags – Part Two – Common Errors

IRS Audit Red Flags – Part Three – Frequent IRS Targets

IRS Audit Red Flags – Part Four – Cash

IRS Audit Red Flags – Part Five – Schedule A and E

IRS Audit Red Flags – Part Six – Employee Audit Red Flags

IRS Audit Red Flags – Part Seven – Schedule C Expenses

IRS Audit Red Flags – Part Eight – Schedule C Losses and Schedule B and D

IRS Audit Red Flags – Part Nine – Margins

IRS Audit Red Flags – Part Ten – The Self Employed/Conclusion

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
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