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IRS Audit Triggers: Top Red Flags That Can Trigger IRS Audits

July 06 2022 •
Tax Assurance

Martha Stewart, Al Pacino, Lionel Richie—what do these high-profile celebrities have in common? They’ve all been audited by the IRS.  When breaking news is released on notable people getting audited, it seems as if they’re extremely common, when, in fact, only about 0.6 percent of individual income taxes are audited each year. But this low number of audits doesn’t mean you’re off the hook. If the IRS suspects any suspicious activity regarding your taxes, they can add you to their list of people to audit.

So, what triggers an IRS audit? That’s what you’re about to find out! Below, we’re going to cover what causes you to get audited by the IRS and the top reporting mistakes taxpayers make. Read through to view the most common IRS red flags that can land you in Uncle Sam’s hot seat, or use the links below to skip to a section of your choosing.

What is an IRS Audit?

Before we dive into what triggers a tax audit, it’s important to understand what an IRS audit is, first. An IRS audit is an examination or review of a taxpayer or business’ accounts and financial information to ensure the provided information is accurate and complies with tax laws. When the IRS conducts an audit, they want to make sure the amount you reported on your individual or business tax return is correct.

Fortunately, most income tax returns aren’t audited, and recently, the number of IRS audits have been on the decline due to a decreasing budget and staff. In total, of the 195,750,099 tax returns filed in 2017, only 991,168 were audited, which is down 42 percent from 2010. This doesn’t mean you should falsify your tax return with hopes of getting away. The IRS still takes tax fraud very seriously, so if they notice any discrepancies on your return, they may come knocking at your door.

Red Flags That Trigger IRS Audits

There are many IRS audit red flags that can land you in trouble. For example, lying on a tax return to get more money will increase your chances of getting audited. Or, falsely claiming deductions can raise IRS red flags. Take a look at common red flags that lead to IRS audit triggers below:

Too much or too little income

If you’re making too much or too little income, your chances of getting audited by the IRS are increased. Overall, the IRS’s 2018 Data Book found that taxpayers with an adjusted gross income between $25,000 and $500,000 were audited the least compared to taxpayers with adjusted gross incomes below $25,000 or more than $500,000.

Why is this? For taxpayers who have a lower adjusted gross income, the IRS may think that you’re claiming too many deductions or failing to report additional income. The 2018 Data Book found that 2.04 percent of those who reported no adjusted gross income were audited by the IRS in 2018, while 0.44 percent of those reporting between $100,000 and $200,000 were audited.

Conversely, taxpayers bringing home a lot of money increase their chances of being audited. This doesn’t mean the IRS doesn’t want you to make money. It means that the IRS might suspect an error or even fraud is at play because you have more money to work with. Below are some stats from the 2018 Data Book regarding high-earning taxpayers:

  • 10 percent of taxpayers making between $500,000 and $1,000,000 were audited
  • 21 percent of taxpayers making between $1,000,001 and $5,000,000 were audited
  • 21 percent of taxpayers making between $5,000,001 and $10,000,000 were audited
  • 66 percent of taxpayers making more than $10,000,001 were audited

As you can see, the more money you make, the more likely you are to be audited by the IRS.

Typos and math errors

Will the IRS catch my mistake? More often than not, yes. A simple mistake, such as a typo or math error, can trigger an IRS audit. For example, writing down an incorrect number for your income or providing the wrong Social Security number can cause the IRS to look into your tax return deeper.

The IRS uses a computer scoring model called the Discriminant Information Function (DIF) system, which analyzes your tax return and compares it to the returns of other taxpayers in your tax bracket. The DIF system also looks for unreported income, duplicate information, such as two or more people claiming a dependent, and credits and deductions that a taxpayer might not be eligible for. Working with a tax representative is always a safe bet, as they’re professionally trained to prepare and file tax returns to help mitigate the chances of an IRS audit.

Unreported income

Failing to report all of your income is one of the easiest ways to trigger an IRS audit. This is because your employer sends a copy of your W-2 Form to the IRS. If you’re an independent contractor or freelancer and get paid more than $600 for services, the entity that hired you will send a copy of Form 1099-MISC to the IRS.

Additionally, if you invest in stocks or other securities, the IRS also gets a copy of Form 1099-INT or Form 1099-DIV, and lottery winners can expect the IRS to get a copy of Form W-2G, too. So, will the IRS catch a missing 1099-MISC or W2? Most likely. All of these forms are processed through the DIF system, so an IRS red flag can be raised if any wages are unreported.

Deciding not to report any income, including cash from tips and other services, can come to haunt you down the line because the IRS likely has a copy of what you earned throughout the year. To prevent an IRS audit, make sure you contact your employer or the issuer of your 1099 forms to ensure you have all of the necessary forms to file your tax return accurately.

Excessive tax deductions

There are a variety of tax deductions that can lower your tax liability for the year. However, this doesn’t mean you should try and claim every tax deduction. Claiming a deduction that you’re not eligible for or a significant number of deductions can increase your chances of getting audited.

IRS audits are often triggered when deductions are itemized. Your itemized deductions audit risk is typically higher because the IRS will compare your tax return to those with similar incomes. If you have expenses that are drastically different than others similar to you, it might raise Uncle Sam’s eyebrow.

This doesn’t mean you shouldn’t apply for every deduction you’re eligible for. To prevent an IRS audit, make sure you have documents that support each itemized deduction, such as receipts, statements, and getting items appraised if you donate them to charity. Surviving an IRS audit without receipts and documentation can be challenging, so make sure to hold onto these essential files for at least seven years.

Deducting 100 percent of a business vehicle

Deducting 100 percent of a business vehicle is another IRS audit trigger. This is because the IRS knows that it’s highly unlikely a vehicle is used solely for business purposes. For example, mileage and gas are deductible expenses for your business vehicle. But, using the vehicle for your commute and deducting the miles isn’t eligible for deduction. If you have a second personal vehicle registered under your name, you might be able to deduct 100 percent of your business vehicle. However, you have to have supporting documentation and proof.

Failure reporting cryptocurrency

Virtual currencies are an up and coming payment method and form of investment that the IRS is keeping their eyes on. Buying or selling things with cryptocurrency is a taxable transaction that needs to be reported to the government. The same goes if you’re mining cryptocurrencies like Bitcoin, as Coinbase, the digital currency wallet, sends information to the IRS. Whether you make a gain or loss or produce income from cryptocurrency, it must always be reported. If not, the IRS has the power to conduct an audit.

Cash-based businesses

Many cashed-based businesses, such as restaurants, bars, and barbershops and salons, are more prone to being audited by the IRS. This is because it’s easy for business owners and employees to deposit or spend their cash and forget about it come tax time. For the IRS, verifying income earned through cash is tricky, and is called the Tax Gap, which is unreported money spent in the U.S. economy. If you work for a cash-based business, having a lifestyle that doesn’t match your income can raise an IRS red flag, as it’s highly unlikely to be driving a new Tesla on a reported salary of $55,000.

If you’re a Schedule C filer and overstate your expenses or under-report your income, the IRS may become suspicious of your activities. Whenever you report a loss, especially multiple years in a row, the IRS may suspect you’re not disclosing all of your financial information. When tax season comes around, make sure your records support your tax return.

Claiming the Earned Income Tax Credit

The Earned Income Tax Credit (EITC) or Earned Income Credit (EIC) is a tax credit for working individuals with low to moderate incomes and must meet certain requirements to qualify. Some requirements include having a qualified child listed as a dependent or meeting the requirements for not having a qualified child, having a Social Security number, and having earned income and adjusted gross income within specified limits.

Because the EITC reduces your federal tax liabilities, the IRS pays close attention to those who claim this tax credit. Falsifying earned income to claim tax credits can land you in serious trouble with the IRS, resulting in an Earned Income Credit audit. The Preventing Americans from Tax Hikes (PATH) Act requires the IRS to not issue a refund on tax returns that claim the EITC until February 15. This is so the IRS can have enough time to review each tax return that claims this credit to ensure the taxpayer qualifies and isn’t committing fraud.

Self-employed workers

Freelancers and sole proprietors are eligible for more tax deductions than most taxpayers. This is because self-employed workers don’t have a portion of their taxes paid for by their employer because they’re their own boss. With that said, self-employed workers can qualify for mileage deductions, deductions for travel and meals, and other expenses to keep their business running. All of these expenses are listed on Schedule C of their tax return, which goes through the DIF system to compare your return to the norm of tax returns for other professions.

Self-employed workers attract additional scrutiny from the IRS due to the fact they’re able to qualify for a variety of deductions. If you’re a self-employed worker, make sure to triple check your tax return to ensure every deduction you report can be backed up by a paper trail of evidence.

Home-based businesses

Conducting business from a home office can also raise an IRS audit red flag. This isn’t saying you can’t work from home, but that you need to be extra careful when you claim home office deductions. When claiming home office deductions, you need to ensure that your home office is used strictly for business purposes and nothing else. This means you can’t list your dining room table as your office or have your children play in your home office after business hours.

If the IRS suspects that you’re claiming personal expenses as business expenses or the business use of your home isn’t entirely used for business purposes, they may audit you. Refer to IRS Publication 587 to learn more about the business use of your home.

Claiming a hobby as a business

The purpose of a business is to generate a profit. If you’re continually reporting losses for your business, the IRS may audit you to determine if it’s actually a business or a hobby. The IRS will deem your business a hobby if you don’t show a net profit from at least three of the past five years. Additionally, if the income you generate from your hobby isn’t used to help make ends meet, or if you don’t devote the majority of your time and money to your work, the IRS will see it as a hobby and not a business.

Reporting a hobby as a business means you must run your hobby like a business. Having the necessary documentation and reports, along with the intention of making a profit, proves your hobby is actually a business. If your hobby doesn’t qualify as a business, you may be able to take advantage of the IRS’s rules on hobbies.

Top Reporting Mistakes Taxpayers Make

After going over what triggers an IRS audit, it’s important to know the top reporting mistakes taxpayers make to prevent raising an IRS red flag. Take a look:

  • Failing to report all of your income: It’s easy to remember to report income made from your place of employment, but it’s important to remember other sources of taxable income, such as unemployment benefits, gambling winnings, investment accounts, and canceled debt.
  • Claiming the wrong or too many deductions: There are dozens of deductions taxpayers can take advantage of to reduce their tax liability. However, claiming deductions that you’re not eligible for, or too many, can result in an IRS audit, penalties, fees, and even jail time if it was intentional or fraudulent.
  • Not filing on time or failing to file: Not filing on time or failing to file altogether can result in a failure to file fee. If you’re running out of time, you can always file for an extension. However, it’s important to remember that even though you applied for an extension to file, you still need to pay your taxes by the tax deadline, which is usually April 15.
  • Math errors: There is a lot of math involved when it comes to filling out your individual tax return. This can make it easy to make a careless mistake, which can result in the IRS reviewing your tax return. Make sure you double-check each number to ensure it’s correct.
  • Incorrect or missing information: As you fill out your federal tax return, make sure you fill in every single box, or else the IRS won’t be able to process your return. Additionally, make sure all of your information is correct. This means writing legibly, not rounding numbers, and keying in the correct information from your 1099 and W2 forms.

How Does the IRS Notify You of an Audit?

Are you worried that you may have made a mistake on your individual tax return that will lead to an IRS audit? If so, you may be asking yourself, “how does the IRS notify you of an audit?” The IRS will notify you of an audit through mail. They will never correspond with you through email or phone, so if you receive a phone call or email from the IRS, it can be a scam.

If you’re chosen for an audit, the IRS will either manage it through mail or an in-person interview where they will review your records. This interview will either be at an IRS office or at your home, business, or accountant’s office.

It’s also important to remember that just because you’re being audited doesn’t mean you’ve done something wrong. Sometimes, an audit is random just to look at statistical norms, while other times it’s because you are in trouble. However, of the roughly 1.0 million examinations of tax returns in 2018, almost 30,000 of them resulted in additional refunds to the taxpayer, amounting to more than $6.0 billion.

Wrapping Up on What Triggers an IRS Audit

Receiving a letter in the mail from the IRS is always intimidating, especially if it’s a notice for an audit. There are numerous IRS audit triggers, such as claiming too many deductions, typos and math errors, little or high income, and under-reporting income.

To prevent an IRS audit, it’s important you do your due diligence to prepare and file your individual tax return accurately. At Community Tax, we provide tax audit help so you don’t have to go through this complicated process alone. Our tax audit representation is second-to-none, and we’ll ensure you navigate these challenging waters with ease and a positive outcome.

Hiring a professional tax audit representative can help you handle the paperwork that comes with an IRS audit. Community Tax’s team of tax professionals are here to help you resolve your tax situation. Contact us today or chat live with one of our online representatives to get started today.