IRS audit triggers: the most common reasons and how to avoid
Lots of people are audited by the IRS every year. While it’s an inconvenience, it’s usually nothing to worry about. The agency uses software to identify tax returns that fall outside its statistical norms, which could be you for a number of reasons.
What is an IRS audit?
IRS, or the Internal Revenue Service, carries out around half a million audits on filed taxes every year.
Around one in 220 people need to provide extra information about their personal or business accounts taxes to prove their filing was accurate.
Most are carried out via mail, but some IRS audits take place in person — particularly if you have a large volume of proof to provide, which would be impractical to send.
If that’s the case, you’ll be invited to the closest IRS office where you can simply show your documents.
What triggers an IRS audit?
The agency states that it uses statistical formulas created from the results of its National Research Program, which generates ”norms” all tax returns can be compared to.
Tax returns that fall significantly outside these averages may be deemed worth investigating.
There are lots of reasons why you may be chosen for an IRS audit, and you’ll be given the reason in the audit notice.
Learn nine of the most common audit triggers below. Remember — if you’ve been truthful when preparing your taxes, and have your financial information properly filed, an audit should be a minor inconvenience at best.
The most common IRS audit triggers
1. Incorrect or incomplete return
Missing a section or an entire form that you need to fill out is a sure fire way to get an IRS audit.
The agency will need to see every cent of taxable income and even an oversight could appear as though you’re concealing money.
There are various penalties you can be hit with, including a Failure to File fine ($435 or the amount of tax you owe from your underreported tax).
While it’s unusual to be fined for a genuine mistake, you could face serious fines if the IRS believes you missed information on purpose.
2. No declared income or underreported income
Even if you’re not currently in employment and believe you have nothing that counts as income, declaring 0 on your tax return looks extremely suspicious.
You may also be subject to an audit if your income is a lot lower than your peers — like business partners or fellow employees in the same pay bracket.
The IRS has recently focused a lot of attention on lower earners.
According to CNBC, people with an income of less than $25,000 who qualify for the Earned Income Tax Credit were five times more likely to be audited.
All taxable social security benefits must be declared, as does everything from bank interest to dividends to rental income.
Even if you’re not actively working, it’s extremely unlikely your income is a genuine 0.
3. Income over $1 million
High earners frequently attract regulatory interest and IRS enforcement agents reportedly spend a quarter of their time auditing millionaires.
It's unsurprising, considering the level of potential tax recovery possible for the wealthiest people in society.
Some wealthy individuals make use of tax planning schemes, which reduce their individual or company tax bill.
While most are entirely legal, others cross into tax avoidance — something the IRS wants to eradicate.
4. A sudden increase or decrease in income
Let's say your income jumps from $50,000 to $300,000 in one year, or does the reverse.
Your unusual luck (good or bad) may trigger an audit. A significant increase could look suspicious, as it may indicate you have not correctly declared all sources in previous years. Or, you may have received income or a gift from a not-entirely legal source.
A sudden decrease, on the other hand, could mean you’re hiding part of your income or assets to avoid being taxed on them.
5. Unusually high deductions
If you’re claiming far higher expenses than most people on your income, it’s likely to spark the IRS’s interest.
The standard deductions will increase for 2022/23 tax year — to $25,900 for married couples jointly filing, $12,950 for anyone filing as an individual, and $19,400 for any ‘heads of households.’
If your expenses are disproportionately high, there’s a chance the IRS will conduct an audit.
6. Multiple years of losses
It's unfortunate that struggling businesses are more often targeted for an IRS audit, given that most in this situation would prefer not to focus on their finances.
The IRS sees high or consistent losses or write-offs as a red flag for underreported income, so you’ll need to show that your recorded performance is correct.
7. Related investigations
Your returns may be flagged if a business partner, investor or other taxpayer you’ve had significant transactions with is being audited.
This is particularly likely if a previous audit revealed mistakes or intentional dishonesty that led to financial penalties.
The IRS may have concerns about the accuracy of your organization's financial recording, or that you’re colluding with another to avoid paying the correct amount of tax.
8. You run a cash-heavy business
It's easy for cash to slip under the radar of the taxman, often unintentionally.
The IRS has a record of auditing cash-based businesses more frequently than others as it is easier to conceal income from paper transactions.
Make sure you keep robust records of your transactions so it’s easy to show the IRS you’re doing the right thing.
9. Financial errors
Even a genuine error will be taken seriously by the IRS.
You may have simply mistyped an expense as $5,000 rather than $50, causing your deductions to look disproportionately high.
Or if your accounts look too neat (i.e., you’ve rounded all your expenses to the nearest ten rather than the nearest dollar), it could be a red flag that they’re not accurate.
Whatever the reason, a suspected mistake is a common reason for an IRS audit.
If you found this article useful, you might also find our article on energy tax credits informative, too.
Kate has written for leading publications and blue chip companies over the last 20 years.