Sam Brotman, JD, LLM, MBA September 29, 2013 7 min read

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

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

Unreimbursed employee expenses

Unreimbursed employee expenses are perceived to be one of the most common IRS red flags. The IRS frequently reviews unreimbursed employee expenses in audits, as they are widely considered a high abuse category for W2 employees. As a practitioner when reviewing an audit client’s tax return, I often do a quick calculation to determine what percentage of adjusted gross income (AGI) do unreimbursed employee expenses total. Anything over five percent (5%) and I make sure to ask my client about the nature of the expenses taken. Think of it this way: an employer is not likely to pay you a salary only to turn around and make you spend more than five percent (5%) of it on the cost to do to your job. If that is the case, these expenses are usually reimbursable to the employee by their employer. The problem with unreimbursed employee expenses is that many people either throw in personal use expenses into this category or add things that are not tax deductible (like dry cleaning expense). The IRS is catching on quick, however, by not only monitoring your total Schedule A expense (as a percentage of income), but by also looking at others who have your occupation and flagging the outliers for additional screening. Given the history of abuse associated with this category, it is important to be vigilant when totaling your expenses to make sure they meet the requirements of the Internal Revenue Code. Be prepared for the government to take a look at these expenses, as they are one of the common IRS red flags.

Home office deductions for businesses that have are not run from the home

If I were asked to name three IRS red flags where I saw clients get challenged and usually resulted in a change, this category might top my list. Home office deductions and the associated expenses for individuals whose company has a primary location somewhere else tends to trap taxpayers who are not completely familiar with the nuances of the code. Many people misinterpret the rules associated with the deduction while others simply abuse or try and game the system.

The most difficult arguments to make with the IRS are with those taxpayers who receive a W-2 and are someone else’s employee while still claiming a substantial home office deduction for the use of their business. It is really hard to make an argument, absent special circumstances, that an employer either does not provide a suitable primary office location for the employee’s position or does not reimburse them for the out of pocket costs associated with setting up a home office. Furthermore, some occupations statistically do not normally require home offices. It therefore seems obvious that IRS red flags may be raised when you are in one of these professions and claim a home office deduction on your tax return. Just be careful when claiming the deduction and always keep good records (including photos of the office environment). If you claim the deduction, know that you are likely increasing your chances of an audit and be prepared for a potential uphill battle.

Continue to IRS Audit Red Flags – Part Seven – Schedule C Expenses

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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

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