6 IRS Audit Red Flags Every Practice Owner Should Know

By Brian Giesecke, CPA/EA | Giesecke Advisory

Have you ever filed a tax return and thought... what if this is the one that gets flagged?

That little knot in your stomach. The vague worry that something might not be right — even though you're doing things legitimately.

You're not alone. Almost every practice owner I talk to has had that thought at some point. And the fear of an audit can actually be worse than the audit itself... because it stops people from taking deductions they're genuinely entitled to.

Let's fix that. Let's talk about what actually triggers IRS attention, how audits really work, and the six red flags worth understanding — so you can file with confidence instead of anxiety.

How the IRS Actually Selects Returns for Audit

First, some reassurance.

The overall audit rate for individuals is low — historically around 0.4% to 0.7% in recent years. That means for every 1,000 returns filed, fewer than seven get audited. For small businesses filing Schedule C, the rate is slightly higher, but still relatively modest.

The IRS doesn't have agents sitting in a room reading every return. They use computer algorithms — a scoring system called the Discriminant Information Function, or DIF score — to flag returns that look unusual compared to statistical norms for your income level and industry.

A high DIF score doesn't mean you did anything wrong. It just means something on your return stood out from what the system expected.

Here's the other thing most people don't realize: most "audits" aren't the full sit-down-with-an-agent experience you see in movies. The majority are correspondence audits — a letter from the IRS asking you to substantiate a specific item. You mail in your documentation, they review it, and it's resolved.

Full field audits are rarer. They happen, especially for higher-income taxpayers and business owners. But they're the exception, not the rule.

Now... what actually raises those flags?

Red Flag #1: High Deductions Relative to Income

This is the most common trigger. The IRS knows what's typical for your industry, income level, and filing type. When your deductions are significantly outside those norms, you stand out.

If you're a solo dermatology practitioner reporting $400,000 in revenue and claiming $60,000 in meals and travel... the system is going to notice. That doesn't mean it's wrong. Maybe you have a legitimate reason. But you'd better be able to explain it.

The key isn't to shrink your deductions out of fear. It's to make sure every deduction is real, documented, and defensible.

If someone asked you to justify any line item on your Schedule C, could you pull out the receipts and records? If the answer is yes, take the deduction confidently. If the answer is "I'd have to scramble"... that's worth addressing.

Red Flag #2: Consistent Losses Year After Year

Claiming a business loss on your taxes isn't a problem in itself. Businesses have bad years. Startups take time to become profitable.

But if your business shows a loss year after year — especially three or more years out of five — the IRS may start asking whether it's really a business... or a hobby.

The hobby loss rules under IRC Section 183 say that if you're not genuinely trying to make a profit, you can't deduct your losses against other income. The IRS looks at several factors: Do you keep organized books and records? Do you have expertise in the field? Have you made a profit in prior years? Do you depend on the income?

For most medical practices, this is a non-issue. You're clearly running a real business with real patients and real revenue.

But if you have a side venture — maybe a consulting thing or a passion project — and it's consistently losing money with no clear path to profitability... it could draw scrutiny. Just be aware of how it looks on your return.

Red Flag #3: Large Cash Transactions

Cash is harder for the IRS to trace than checks, credit card payments, or insurance reimbursements. They know it. And industries that deal heavily in cash tend to get more attention.

Financial institutions are required to report cash transactions over $10,000 on Currency Transaction Reports. And if someone structures deposits to stay just under that threshold, that's a red flag on its own — it's called "structuring," and it's something the IRS actively watches for.

For most medical practices, this isn't a major concern. The bulk of your revenue flows through insurance carriers and credit card processors, all of which generate documentation automatically.

But there are exceptions. Cosmetic procedures often involve direct patient payments — sometimes in cash. Cash-pay concierge models are growing. If you have significant cash income from any source, make sure you're reporting it accurately and keeping clean records.

The IRS has information from banks and payment processors. If the numbers don't line up with what you report, that's a problem.

Red Flag #4: Home Office Deduction Done Wrong

The home office deduction is perfectly legitimate. I've written about it before, and I encourage practice owners to take it when they qualify.

But here's the thing... it's also one of the most historically abused deductions, so the IRS pays extra attention to it.

The rules are straightforward: the space must be used regularly and exclusively for business. A dedicated room where you do charting, admin work, and practice management qualifies. The corner of your dining table where you occasionally check email does not.

Common mistakes I see:

• Claiming a room that doubles as a guest bedroom or playroom
• Inflating the square footage of the dedicated space
• Not tracking actual home expenses when using the actual expense method
• Claiming the deduction when there's no real home office to speak of

If you meet the requirements — regular, exclusive use for business — take the deduction. You've earned it. But make sure it's clean. Have photos of the space, know the square footage, keep records of your home expenses. Don't give the IRS a reason to question it.

Red Flag #5: Round Numbers That Suggest Estimation

This one is subtle, but it matters.

If every expense category on your return is a nice round number — $10,000 in travel, $5,000 in supplies, $3,000 in meals, $2,000 in continuing education — it sends a signal.

Real expenses almost never come out to perfect round numbers. When they do, it suggests you're estimating rather than tracking. And estimation tells the IRS that your records might not hold up under scrutiny.

This doesn't mean a single round number will trigger an audit. But a pattern of round numbers across multiple categories contributes to a return that looks... approximate. Sloppy. Like it wasn't based on actual records.

The fix is simple: track your expenses as they happen. Use a bookkeeping system. Keep receipts. When your return reflects actual numbers — $9,847 in travel, $4,612 in supplies — it signals that real tracking is happening behind the scenes.

Good bookkeeping solves this problem before it starts.

Red Flag #6: Mismatched Information Returns

The IRS receives copies of your W-2s, 1099-NECs, 1099-MISCs, 1099-INTs, K-1s, and other information returns. Before they ever look at your tax return, they already know a lot about your income.

If what you report doesn't match what they received... you'll hear from them.

This is actually the most common type of IRS notice. And it's usually not an "audit" in the traditional sense — it's an automated matching notice (typically a CP2000) that says: "We think you owe more because this number doesn't match."

Common causes:

• A 1099 from a payer you forgot about
• A K-1 from a partnership entered incorrectly
• A W-2 with a typo that you didn't catch
• Interest or dividend income from an account you didn't realize generated a form

The fix: before you file, gather every information return you received. Compare them to what's on your return. Make sure the numbers match. If a 1099 is wrong, contact the issuer to get it corrected — don't just ignore it.

This is one of the easiest red flags to avoid. A little diligence at filing time saves a lot of hassle later.

The Real Takeaway: Don't Let Fear Stop You

Here's what I want you to walk away with.

The audit rate is low. Most audits are correspondence audits that get resolved with documentation. And the best defense against any audit — correspondence or otherwise — is good records and reasonable positions.

Don't avoid legitimate deductions because you're afraid of drawing attention. If you're entitled to a home office deduction, take it. If you bought equipment under Section 179, deduct it. If you maxed out your retirement contributions, claim them.

The goal isn't to be invisible to the IRS. The goal is to be defensible.

That means: take what you're owed, document everything, and don't get creative in areas where creativity isn't warranted. Reasonable positions, backed by records, stand up to scrutiny.

A Simple Self-Check

Here's a question worth asking yourself before you file...

For every significant deduction on your return, could you produce documentation if the IRS asked?

Receipts. Mileage logs. Bank statements. A home office photo and square footage measurement. Retirement plan contribution records.

If the answer is yes for every major item... you're in good shape. File with confidence.

If the answer is "I'd have to dig" or "I'm not sure"... that's not a reason to panic. It's just a signal to tighten up your recordkeeping going forward.

Good documentation isn't just audit protection. It's peace of mind.

Your Next Step

Pick one area from this list where your records feel weakest. Just one.

Maybe it's your home office documentation. Maybe it's matching up your 1099s. Maybe it's getting rid of those round-number estimates by setting up real expense tracking.

Start there. One area, cleaned up, puts you in a stronger position than you were yesterday.

And if you want a broader framework for making sure your tax situation is organized and optimized... I put together a checklist covering all the major planning areas for medical practice owners.