From the Tax Law Offices of David W. Klasing - What does the IRS do when it discovers Large, Unusual or Questionable Items on your returns?

IRVINE, Calif., Aug. 14, 2024 /PRNewswire/ -- The IRS might open an audit when a tax return does not contain enough information to explain certain large, unusual, or questionable (LUQ) items.

The IRS pays close attention to large, unusual, and questionable items reported on tax returns. Typically, these are any deductions or expenses that are considerable or unconventional for your specific situation. If the IRS flags something in a taxpayer's return as a LUQ item, the agency might proceed with an audit of the taxpayer's return. When the IRS notifies you of an audit, it will also tell you what information is missing and what you need to provide in order to resolve the matter. Audits often involve interviews as well, which we can prepare you for by reviewing the issue. Taxpayers should not ignore audits regarding LUQ items, as doing so could result in financial penalties and other consequences.

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How Does the IRS Define LUQ Items?

Large, unusual, or questionable items raise red flags for the IRS and could potentially result in an audit for taxpayers. Identifying possible LUQ items before filing can help you avoid these issues.

     Large

For example, if you make a considerably large purchase or investment for yourself or your business that does not align with your reported income, the IRS might question the purchase.

Some examples of large items that might raise red flags in the eyes of the IRS include financed high-value real estate purchases, sudden significant medical expenses, and large contributions to retirement accounts. Large cash transactions, windfall gains, or selling a big asset like a second property could also result in questions from the IRS.

     Unusual

Unusual items are anything that is out of the norm for your income and financial situation. For example, the IRS might flag any expense that is out of the ordinary, or you cannot support with the proper documentation. Furthermore, depending on the information you include in your return, the IRS might deem expenses for unconventional work or equipment as unusual.

     Questionable

Questionable items include claiming business deductions for personal expenses or any other activity that raises suspicions regarding your taxes. Regarding LUQ items, there might be some overlap. For example, a substantial purchase that lacks the necessary documentation or is out of the ordinary for a taxpayer's financial situation might be questionable and large, prompting an audit from the IRS.

How Does the IRS Assess LUQ Items?

The IRS uses various methods when assessing large, unusual, or questionable items. For example, the IRS might consider an item's inherent value and size in comparison to other expenses.

The IRS uses data analysis to flag returns with possible LUQ items. Once a return is flagged, the IRS might consider various factors, such as the comparative size of an LUQ item against a taxpayer's other expenses. Even if an LUQ item is small compared to a taxpayer's taxable income, the IRS might deem it large based on its absolute size.

The IRS will also consider an item's inherent nature and whether it makes sense for you to own it based on your income and finances. If a taxpayer intentionally misled the IRS by leaving out certain schedules or information, that could indicate the need for an audit.

If information about an LUQ item that should be in your return based on your taxpayer status is missing, the IRS might examine the return further and subject you to an audit. For example, reporting sales of stock without also reporting dividend income could be a red flag.

Whipsaw issues could arise when inconsistencies regarding LUQ items are reported on the returns of those involved in the transaction. These types of issues are common when reporting child support and alimony, as well as in real estate transactions.

Suppose you disagree with or are confused by the IRS' assessment and classification of LUQ items in your return. In that case, we can examine the issue further to see if the IRS has made an error in notifying you of a potential audit.

How Can Taxpayers Prepare for an IRS Audit of LUQ Items?

If, after a preliminary assessment of LUQ items, the IRS deems your return necessary for further investigation, it might request that you submit to an interview or provide additional information or documentation during an audit. Don't ignore this notice, as doing so could worsen your situation.

The IRS will inform you of an audit before it takes place. If you get notice of an audit, that does not necessarily mean anything is wrong with your return; the IRS sometimes randomly audits taxpayers for no specific reason.

Audits can take place in person or through the mail. For example, if the IRS requests proof of receipts or bills pertaining to certain LUQ items, our Dual-Licensed Tax Attorneys and CPAs can promptly send that information through the mail to the IRS. Alternatively, if the IRS needs a substantial amount of information, the audit can happen in person.

In addition to requesting documentation to further assess a large, unusual, or questionable item, the IRS might ask you to submit to an interview. During an interview, an IRS agent might ask detailed questions about the large, unusual, or questionable item in question to confirm your compliance with reporting requirements.

Do not ignore a notice of an audit for a large, unusual, or questionable item. The IRS might pursue civil and criminal penalties against you if you do. Often, if taxpayers can explain LUQ items by providing the IRS with the proper documentation during audits, they can resolve matters without facing any fines or other substantial consequences.

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