While the odds of a tax audit are surprisingly low (less than 1% for people earning between $25,000 and $100,000 per year), some taxpayers are at higher risk than others. If you’re wondering what the top IRS audit triggers are, you’ve come to the right place.
Don’t immediately assume that you’ve done something wrong just because you’ve been chosen for an audit; sometimes, it’s just the luck of the draw. The IRS has a National Research Program that randomly examines a certain number of tax returns each year to shed light on the percentage of completed tax returns that contain errors.
Here are some other IRS audit red flags that could increase your chances of having tax returns examined:
1. The Computer Got You
The IRS uses a system called the Discriminant Information Function (DIF) to scan every tax return for anomalies, mistakes, or deductions that seem out of place. For example, it can automatically see whether multiple people claimed the same children as dependents.
The DIF compares your tax return to those of people with similar income (or in similar industries if you’re self-employed). Anything on your tax return that’s outside the norm can cause the DIF to flag your return. If that happens, a human will have to review your return, and they may refer you for an audit.
2. You Have Missing Income
One of the most common IRS audit triggers is income that’s missing from your tax return. Nearly all income—including wages, capital gains, dividends, interest, or miscellaneous income—must be reported. Other sources may report this information about you to the IRS, raising a red flag if your tax return doesn’t match.
For example, the IRS receives copies of all W-2 Forms, as well as 1099s reporting freelance/self-employed income. They receive 1099 Forms from stock exchanges and many cryptocurrency exchanges. They even receive reports on gambling or lottery winnings. They have other ways of tracking down income, too, so be sure to account for every penny.
Investors in stocks, bonds, real estate, cryptocurrency, or other types of investments should be extra careful with their tax reporting; each additional source of income adds more potential for error. If you need help with a complex tax return, contact our experienced tax attorneys.
3. You Claimed a Lot of Credits and Deductions
If you’re claiming an unusual number of deductions or credits compared to others in your tax bracket, or deductions that are inconsistent with previous years’ earnings, that can draw attention from the IRS. It’s perfectly fine to claim legitimate credits and deductions, but you should be prepared to back them up in the event of an audit.
The Earned Income Tax Credit (EITC) for parents is frequently misused, and therefore often examined. Write offs for charitable donations, substantial business losses, and real estate investments are also common targets of IRS scrutiny.
Do you run a small business, particularly on a part-time basis? Be sure the IRS will consider your venture a legitimate business; the Tax Cuts and Jobs Act of 2018 tightened restrictions on who can claim business expense deductions. If your business is deemed a “hobby,” your claimed deductions may be invalidated.
4. You’re a Very High Earner
While most taxpayers’ chance of audit is less than 1%, the odds increase once you earn $500,000 or more in taxable income. Those reporting more than $10 million have the highest risk of a tax audit.
To make the most of its resources, the IRS focuses on examinations where it feels more tax liability can be uncovered. Because very high earners tend to have multiple sources of income and more complex tax situations, they make a good target for examinations.
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5. You Have Offshore Accounts or Assets
Offshore accounts and assets can be IRS audit triggers, whether they’re reported correctly or not. If you have financial interest overseas, you may be required to file an FBAR or another offshore disclosure form. The IRS is keenly interested in offshore income because it’s often been used to evade taxes.
Many foreign banks are now required to send the IRS a list of American account holders; if the IRS identifies you this way and you haven’t reported your foreign income, that could be certainly trigger a tax audit.
On the other hand, if you do properly report your foreign income, the IRS may wish to verify the amounts you’ve reported. (Still, the FBAR non-filing penalty could be worse than facing an audit!)
6. You Amended Your Return to Lower Taxable Income
Generally speaking, we have not found in our practice that filing an amended tax return increases the risk of an audit—especially if you’re amending to report more income, thereby increasing the amount you owe. However, if you amend your tax return to lower your tax liability—for example, retroactively claiming the Section 1202 QSBS exclusion, which can make $10 million or more non-taxable—that could potentially trigger an IRS audit.
If you want to amend a prior year tax return, our attorneys can help you understand the pros and cons for your specific situation.
7. You Made Large Cash Payments or Deposits
Another potential IRS audit trigger is making large cash payments or depositing large amounts of cash in the bank.
When any individual or business receives a cash payment of $10,000 or more, they must fill out Form 8300 reporting the transaction to the IRS. The form includes the name and address of the person who made the payment or deposit.
If you’re identified to the IRS this way, that could be a red flag for an audit—especially if it doesn’t make sense for you to have that type of cash on hand based on the income you reported.
8. Audit by Association
Finally, if you’re financially involved with another individual or business that’s been audited, the IRS may uncover your information during the examination and decide to audit you, as well.
Worried About IRS Audit Triggers? We Can Help
Whether you’re undergoing an IRS audit or trying to avoid one, our tax lawyers have the knowledge and experience to help. We’re here to provide much-needed clarity for your situation and guide you safely to the other side. The first step is to contact us online or call (847) 580-1279!