Why LA Returns Get Flagged

The entertainment industry practically writes the playbook for audit triggers. A screenwriter earning $250,000 one year and $40,000 the next, with $30,000 in home office deductions and $15,000 in “research” expenses, is going to draw attention from the IRS’s Discriminant Inventory Function (DIF) scoring system.

Real estate is the other big magnet. Los Angeles County has some of the highest property values in the country, and returns involving rental income, depreciation on million-dollar properties, and 1031 exchanges are reviewed at elevated rates. The IRS has dedicated teams that focus on real estate professionals claiming material participation — a designation that lets them deduct rental losses against ordinary income.

Cash-heavy businesses get extra scrutiny too. LA has a huge number of restaurants, retail shops, and service businesses where the IRS suspects underreported income. If your reported revenue looks low relative to your industry benchmarks, that gap alone can trigger an audit.

How Federal Audits Work

The IRS runs three levels of audits, and understanding which one you’re facing determines how you should prepare.

Correspondence audits are the most common — you get a letter asking for documentation on one or two specific items. Maybe your charitable contributions seem high relative to your income, or a 1099 from a production company doesn’t match what you reported. You mail the records back. If they check out, the case closes.

Office audits mean an in-person appointment at a local IRS office. In LA, that’s usually the IRS building on Wilshire Boulevard. The examiner will have a list of items they want to review, and the meeting typically lasts two to four hours.

Field audits are the serious ones. A revenue agent comes to your home or business to review records firsthand. These are common for business owners, real estate investors, and high-income taxpayers with complex returns. They can last weeks or months.

California FTB: A Separate Problem

California’s Franchise Tax Board doesn’t wait for the IRS. The FTB has its own audit selection process, its own agents, and its own enforcement priorities. For LA residents, two FTB audit types come up repeatedly.

Residency audits are the FTB’s bread and butter. California’s top income tax rate is 13.3% — the highest in the nation — so the state has a powerful financial incentive to prove that people claiming to have moved to Nevada, Texas, or Florida are still California residents. The FTB will examine your cell phone records, credit card statements, social media check-ins, and even pet veterinary records to establish where you actually lived.

The “safe harbor” rule says you need to be outside California for at least 546 days in a two-year period after changing domicile. Fall short by even a few days and the FTB will treat you as a continuing resident owing tax on worldwide income.

Business nexus audits target out-of-state businesses that the FTB believes have enough California connections to owe state tax. If you live in LA and have clients or partners in other states, or vice versa, the sourcing rules get complicated fast.

Preparing for an Audit in LA

When you get the notice, read it carefully before reacting. The letter specifies exactly which tax year and which line items the IRS or FTB wants to examine. Gathering the right records early is half the battle.

For entertainment industry professionals in LA, that means keeping organized records of:

• Agent and manager commission statements (typically 10-15% of gross earnings)
• Union dues — SAG-AFTRA, WGA, DGA, IATSE
• Headshots, demo reels, and self-promotion costs
• Travel to auditions and filming locations outside LA County
• Home office or dedicated workspace documentation

Hiring a CPA or enrolled agent for audit representation is almost always worth the cost. They can attend meetings on your behalf using a Form 2848 Power of Attorney, and experienced practitioners know the arguments that resonate with examiners and the ones that don’t.

Statute of Limitations and Record Retention

The IRS generally has three years from your filing date to audit a return. If they suspect you underreported income by more than 25%, they get six years. No time limit applies to fraud or unfiled returns.

California follows similar rules but has a twist: the FTB gets an extra year beyond the federal statute in most cases, and four extra years for California-source income adjustments. This means the FTB can audit your 2022 California return until 2029 in some scenarios. Keep your records accordingly.