# Tax Audit Risk

> IRS audit risk assessment skill that scores tax returns for audit probability, identifies specific red flags with quantified thresholds, calculates penalty exposure, and recommends documentation improvements. Covers 30+ audit triggers including Schedule C deduction ratios, charitable donation percentages, home office claims, vehicle use, S-Corp reasonable compensation, hobby loss rules, related party transactions, crypto reporting, and Illinois-specific triggers. Uses weighted risk scoring (1-100 scale) with letter grades. Triggers on: audit risk, IRS audit, audit probability, red flags, audit triggers, DIF score, penalty, penalties, audit defense, documentation, statute of limitations, hobby loss, reasonable compensation, audit exposure, tax risk, compliance risk, IL audit.

- Skill: `davidjelinekk/tax-audit-risk` (Agent Skill, multi-file: 4 files)
- Install (CLI): `npx skillmds@latest add davidjelinekk/tax-audit-risk`
- Raw SKILL.md: https://api.skillmd.com/api/skills/davidjelinekk/tax-audit-risk/raw
- Safety review: pending
- Works with: Claude Code, Claude.ai, OpenAI Codex
- Category: Security
- License: MIT
- Author: davidjelinekk (https://skillmd.com/u/davidjelinekk)
- Updated: 2026-09-22
- Page: https://skillmd.com/skills/davidjelinekk/tax-audit-risk

---


# IRS Audit Risk Assessment — Red Flag Detection & Risk Scoring

Score a tax return's audit probability, identify specific red flags, quantify
penalty exposure, and recommend improvements to documentation and compliance.

**DISCLAIMER**: Audit risk scoring is based on publicly available data about IRS
enforcement patterns and practitioner experience. The IRS's actual DIF scoring
algorithm is classified. This tool provides directional guidance, not a guarantee
of audit or non-audit outcome.

## When to Use This Skill

- Reviewing a return before filing to identify audit red flags
- Assessing whether a specific deduction or position is risky
- Understanding penalty exposure for an aggressive tax position
- Checking documentation adequacy for claimed deductions
- Evaluating whether an entity structure creates audit risk
- Understanding statute of limitations for a prior return
- Assessing hobby loss risk for a side business
- Evaluating related party transaction compliance across multiple LLCs
- Checking crypto/trading income reporting compliance

## Context Needed

For a comprehensive risk assessment, collect:
1. **Filing status and AGI** — Audit rates vary dramatically by income level
2. **Income sources** — W-2, Schedule C, K-1, investments, crypto
3. **Specific deductions claimed** — Home office, vehicle, charitable, meals, travel
4. **Entity types** — Sole prop, LLC, S-Corp (each has different risk profile)
5. **Years of profitability/loss** — Consecutive losses trigger hobby loss scrutiny
6. **Documentation status** — Do they have receipts, mileage logs, etc.?
7. **Any prior audits?** — History affects future selection

## Risk Scoring Methodology

### Overall Risk Score (1-100)

Load `references/risk-scoring.md` for the complete weighted scoring model.

Score each applicable category, then calculate weighted average:

| Category | Weight | Description |
|----------|--------|-------------|
| Income Reporting | 25% | Unreported income, 1099 matching, cash business |
| Deduction Ratios | 20% | Schedule C deductions vs income, specific item thresholds |
| Entity Compliance | 15% | Reasonable comp, K-1 accuracy, basis tracking |
| Documentation | 15% | Receipt quality, contemporaneous records, logs |
| Special Positions | 15% | Home office, hobby loss, REPS, crypto |
| Historical Factors | 10% | Prior audits, compliance history, return complexity |

### Grading Scale

| Grade | Score | Risk Level | Action |
|-------|-------|------------|--------|
| A | 0-15 | Very Low | No action needed |
| B | 16-35 | Low | Minor documentation improvements |
| C | 36-55 | Moderate | Review flagged items, improve documentation |
| D | 56-75 | High | Consider amending or adjusting positions |
| F | 76-100 | Very High | Professional review strongly recommended |

## Red Flag Checks

Load `references/red-flags.md` for complete thresholds and scoring.

### Critical Red Flags (Score: 8-10 each)
1. **Unreported income** — 1099/W-2 mismatch with return. IRS computers catch this automatically.
2. **Cash business, low reported income** — Income below BLS industry averages for NAICS code.
3. **Schedule C losses 3+ consecutive years** — Triggers hobby loss inquiry (IRC Section 183).
4. **S-Corp zero/minimal officer compensation** — Known IRS enforcement target.
5. **Offshore accounts not disclosed** — FBAR/FATCA non-compliance.
6. **Related party transactions without documentation** — Between commonly-owned LLCs.
7. **Crypto trading with no Form 8949** — "Digital Assets" question answered incorrectly.

### High Red Flags (Score: 5-7 each)
8. **Schedule C deduction ratio >60%** — Well above DIF norms for most industries.
9. **Income >$500K** — Higher audit rate bracket (~0.8%+).
10. **Home office + Schedule C loss** — Combined signals draw attention.
11. **Vehicle 100% business use** — IRS presumes some personal use for passenger vehicles.
12. **Charitable donations >10% of AGI** — Above average; non-cash >$5K requires appraisal.
13. **Rental losses + REPS claim** — 750-hour test is heavily challenged.
14. **Multiple Schedule C businesses** — Especially if some show losses to offset others.
15. **Large non-cash charitable donations** — Conservation easements especially targeted.

### Moderate Red Flags (Score: 3-4 each)
16. **Schedule C deduction ratio 50-60%** — Somewhat above norms.
17. **Income $200K-$500K** — Increasing scrutiny bracket.
18. **Charitable donations 5-10% of AGI** — Above average but not extreme.
19. **Round number expenses** — Multiple expenses at exactly $500, $1,000, etc.
20. **Meals >10% of gross receipts** — Elevated for most business types.
21. **Complex return** — Many schedules, foreign accounts, unusual items.
22. **Late-filed return** — Correlates with compliance issues.
23. **Large education credits** — Must substantiate enrollment and expenses.

### Lower Red Flags (Score: 1-2 each)
24. **W-2 only income <$200K** — Very low audit rate (~0.2%).
25. **Standard deduction taken** — Removes itemized deduction scrutiny.
26. **All income has information reporting** — W-2, 1099 matching is clean.
27. **Clean compliance history** — No prior audits or penalties.

## Assessment Workflow

When the user provides their tax situation:

### Step 1: Collect Information
Gather the context listed above. Calculate key ratios:
- Schedule C deduction-to-gross-receipts ratio
- Charitable donations as % of AGI
- Meals/entertainment as % of gross receipts
- Vehicle business use percentage claimed

### Step 2: Score Each Category
Apply the scoring from `references/risk-scoring.md`:
- Score each applicable red flag (0-10)
- Calculate category scores (weighted by severity)
- Calculate overall weighted score

### Step 3: Generate Risk Report

Structure the output as:

```
## Audit Risk Assessment

### Overall Score: [X]/100 (Grade [A-F])
**Risk Level**: [Very Low / Low / Moderate / High / Very High]

### Risk Breakdown by Category
| Category | Score | Key Findings |
|----------|-------|-------------|
| Income Reporting | X/100 | ... |
| Deduction Ratios | X/100 | ... |
| Entity Compliance | X/100 | ... |
| Documentation | X/100 | ... |
| Special Positions | X/100 | ... |
| Historical | X/100 | ... |

### Red Flags Identified
[List each flag with severity, explanation, and recommendation]

### Penalty Exposure
[Calculate potential penalties if positions are challenged]

### Documentation Gaps
[Specific records that should be improved or created]

### Recommendations
[Prioritized action items to reduce audit risk]

### Statute of Limitations
[When the IRS can no longer audit this return]
```

### Step 4: Penalty Exposure Calculation
Load `references/penalty-guide.md` and calculate:
- Accuracy-related penalty (20% of underpayment) if positions are challenged
- Failure to file/pay penalties if applicable
- Information return penalties (1099s) if missing
- Partnership/S-Corp late filing penalties

### Step 5: Recommendations
Prioritize by impact:
1. **Immediate fixes** — Items that can be corrected before filing
2. **Documentation improvements** — Records to create or improve
3. **Position adjustments** — Deductions to reduce or support better
4. **Structural changes** — Entity or compliance changes for future years

## Illinois-Specific Audit Triggers

- Federal-state mismatch (IL requires 120-day amended return after federal changes)
- Use tax non-compliance (online purchases without IL sales tax)
- Residency audit risk (moved out of IL but maintain IL ties)
- PTE tax credit/deduction mismatch between entity and individual
- Sales tax compliance for tangible goods sellers

## Reference Files

- `references/risk-scoring.md` — Complete weighted scoring model with calculations
- `references/red-flags.md` — All 30+ red flags with specific thresholds and DIF factors
- `references/penalty-guide.md` — Penalty amounts, calculation methods, and abatement rules