Understanding Tax Code Sections Commonly Used in Audits

Auditors do not cite the tax code to intimidate; they cite it to identify whether a return meets legal standards for income recognition, deduction substantiation, information reporting, and penalties. Knowing which Internal Revenue Code (IRC) sections most often appear in audits gives you a clear checklist of what records to keep and what explanations to expect. In my practice working with owners and individual taxpayers, early focus on these sections often prevents an audit from escalating.

Why these code sections matter

The IRS frames questions and proposed adjustments using specific IRC sections and related Treasury regulations. An auditor’s reference to a section tells you what legal test they’re applying—for example, whether an expense is “ordinary and necessary” (IRC §162) or whether a home expense meets the exclusive-use test for the home office deduction (IRC §280A). That focused framing makes it possible to gather targeted evidence rather than a scattershot file of documents.

Authoritative sources to consult for each topic include IRS publications (for example, Publication 535 for business expenses, Publication 463 for travel and entertainment, and Publication 587 for the home office) and the IRS recordkeeping guidance (irs.gov/recordkeeping). When statutes are cited, the actual code language is on legal resources such as the Cornell Law School Legal Information Institute (law.cornell.edu). (IRS and publication links appear in each section below.)

Common IRC sections you will see and why

Below are sections auditors most often use during examinations, with plain-language explanations, typical red flags, and practical documentation tips.

IRC §61 — Gross income defined

  • What it governs: The broad rule that gross income includes all income from whatever source derived unless exempt by law.
  • Why auditors cite it: To challenge omitted income (e.g., unreported 1099s, rental receipts, or barter income).
  • Records to have: Bank deposits tied to invoices, 1099s received and issued, contracts, and contemporaneous sales records.
  • Reference: IRC §61 (see Cornell LII) and IRS guidance on income reporting (irs.gov).

IRC §162 — Trade or business expenses (ordinary and necessary)

  • What it governs: Whether an expense qualifies as an ordinary and necessary expense of carrying on a trade or business.
  • Why auditors cite it: To disallow personal expenses claimed as business deductions or to question the business purpose.
  • Red flags: Large, poorly documented deductions; mixed personal/business expenses; recurring personal patterns.
  • Documentation: Receipts showing business purpose, invoices, client communications, calendars, and mileage logs. See IRS Publication 535 for rules (irs.gov/publications/p535).

IRC §274 — Limitations on entertainment, gifts, and certain meal deductions

  • What it governs: Substantiation rules and dollar limits for meals, entertainment, gifts, and some travel costs; many entertainment deductions are disallowed.
  • Why auditors cite it: Meal/entertainment charges lacking contemporaneous documentation or that are personal in nature.
  • Documentation: Who attended, business purpose, date, location, and receipts. See IRS Publication 463 (irs.gov/publications/p463).

IRC §280A — Business use of the home

  • What it governs: Rules for claiming deductions for a home office, including the exclusive-use and principal-place-of-business tests.
  • Why auditors cite it: Home office deductions are highly scrutinized because of frequent misuse.
  • Documentation: Floor plans, photos, time logs showing exclusive business use, Form 8829 (if using regular method). See IRS Publication 587 (irs.gov/publications/p587) and Form 8829 instructions (irs.gov/forms-pubs/about-form-8829).

IRC §6662 — Accuracy-related penalties

  • What it governs: Penalties for negligence, disregard of rules, or substantial understatement of income tax; penalty mitigation options exist for reasonable cause.
  • Why auditors cite it: When the IRS believes underpayment resulted from negligence or a substantial understatement.
  • How to respond: Show reasonable basis, contemporaneous advice from tax professionals, and corrective steps taken. See IRS accuracy-related penalty guidance (irs.gov/businesses/small-businesses-self-employed/accuracy-related-penalties).

IRC §6041 and related information-reporting sections

  • What they govern: Requirements to file information returns (e.g., Form 1099‑MISC / 1099‑NEC) and correct reporting of payments to contractors and vendors.
  • Why auditors cite them: To question whether payers complied with information-reporting rules—unfiled or misfiled 1099s often trigger audits for both payer and payee.
  • Documentation: Contracts, 1099s issued and received, W‑9s, and bank records.

IRC §469 — Passive activity loss rules

  • What it governs: Limits on deducting losses from passive activities (rental real estate) against non-passive income.
  • Why auditors cite it: To deny losses wrongly claimed against active income.
  • Documentation: Evidence of material participation, time logs, and management contracts. See IRS Publication 925 for passive activity rules (irs.gov/publications/p925).

IRC §6651 — Failure-to-file and failure-to-pay penalties

  • What it governs: Penalties for late filing or late payment and the criteria for reasonable cause abatement.
  • Why auditors cite it: When returns or tax payments were late.
  • Documentation: Proof of attempts to file, illness records, IRS notices, and correspondence supporting a reasonable-cause claim.

Practical audit preparation checklist tied to code sections

  • Gather contemporaneous supporting documents (receipts, invoices, contracts, bank statements). (See IRS Recordkeeping guidance: irs.gov/businesses/small-businesses-self-employed/recordkeeping.)
  • Reconcile 1099s and W‑2s to bank deposits and gross receipts (IRC §61 and §6041 issues).
  • Prepare a short narrative explaining the business purpose for large or unusual expenses (helps with IRC §162 and §274 questions).
  • For home office claims, prepare a floor plan and a short diary showing exclusive-use time and business activities (IRC §280A).
  • For vehicle expenses, keep a mileage log and support for actual expenses (Publication 463).
  • If accuracy-related penalties are proposed, assemble any prior written tax advice or documented reasonable-basis positions (IRC §6662).

In my practice, assembling a one‑page audit summary for the auditor—listing the return year, the primary issues, and where key records are in the file—speeds the examination and reduces follow-ups.

How to reduce or avoid penalties

  • Respond promptly and professionally to IRS requests. Timely cooperation often reduces severity.
  • If penalties are proposed under §6662, document reasonable cause (e.g., reliance on professional advice, illness, or natural disaster). The IRS will consider abatement if you can show reasonable cause and good faith.
  • Consider voluntary disclosure or amended returns if errors are found before the auditor raises them; voluntary correction can reduce penalties.

Refer to IRS penalty guidance and the abatement process for details (irs.gov).

When to get professional representation

If an audit raises complex code questions (large §162 issues, passive activity adjustments under §469, or penalties under §6662), hire a CPA, tax attorney, or enrolled agent. They can prepare a representation package, negotiate with the examiner, and, if needed, escalate to the IRS Office of Appeals. See our Small Business Audit Survival Guide for steps to minimize impact and representation tips: Small Business Audit Survival Guide: Steps to Minimize Impact.

For mileage- and vehicle-related documentation, review our more detailed checklist: How to Document Business Mileage to Withstand an IRS Audit.

If the issue involves a home office deduction, our article on home office rules explains exclusive-use tests and safe-harbor calculations: Home Office Deduction: Rules for Remote Workers.

Common misconceptions

  • Myth: “If it benefits my business, it’s deductible.” Reality: Only expenses that meet IRC §162 and are supported by documentation qualify. See Publication 535 (irs.gov/publications/p535).
  • Myth: “I can claim a home office if I work from home occasionally.” Reality: IRC §280A requires exclusive and regular use unless specific exceptions apply.
  • Myth: “I won’t be audited for small return errors.” Reality: Many audits start from mismatches in information reporting (1099s/Forms W‑2) tied to IRC §61/§6041.

Audit response tips (practical)

  1. Read the notice carefully and note deadlines. Don’t ignore IRS correspondence.
  2. Organize records in the order the auditor asks for them. Use tabs or a digital folder with a simple index.
  3. Provide concise explanations supported by documents; don’t volunteer additional unrelated information that can broaden the audit.
  4. If you disagree with proposed adjustments, ask for the legal basis and consider a written protest if the adjustment is large.

See our guide to preparing an audit representation package for more on this process.

Final notes and disclaimer

This article summarizes commonly cited tax code sections in audits and provides practical documentation tips drawn from IRS guidance (Publications 535, 463, 587, and 925) and statute language (IRC sections cited). It is educational only and not a substitute for personalized legal or tax advice. In my practice I recommend contacting a qualified tax professional when an audit involves substantial amounts, complex transactions, or potential penalties.

Authoritative resources

Professional disclaimer: This content is for informational purposes only and does not constitute tax, legal, or accounting advice. Consult a CPA, enrolled agent, or tax attorney for guidance specific to your facts and circumstances.