IRS Audit Red Flags: How to Avoid Getting Tax Audited

Dealing with an IRS audit can be stressful, time-consuming, and potentially costly. As a taxpayer, you want to do everything possible to avoid extra IRS scrutiny and have your tax returns closely examined.

While the majority of individual taxpayers and small business owners don’t get audited, understanding key audit red flags can help you reduce your tax audit risk and avoid raising any problems with the Internal Revenue Service (IRS).

This comprehensive guide by our team at Lewis CPA examines the top factors that capture IRS attention and often trigger audits. We’ll explain what puts your tax return at higher audit risk and provide tips to proactively minimize the chances of an audit. With smart planning, proper documentation, and professional IRS representation, you can steer clear of audit triggers and submission errors.

What Triggers an IRS Audit?

What Triggers an IRS Audit?

The IRS audit processes only a small fraction of the over 160 million annual federal income tax returns filed. So, exactly how many taxpayers face audits each year? The IRS typically releases the prior year's audit rates around 18 months after the filing deadline, which means the final 2023 individual audit rate won't be available until mid-2025. 

However, we can look at the 2021 rate and make a prediction for the future:

  • 2021 individual audit rate: 0.25%
  • 2022 individual audit rate: 0.38%
  • 2023 trends: With the recent influx of funding from the Inflation Reduction Act allocated for enforcement purposes, some experts predict a potential increase in audit rates, particularly for higher-income earners, partnerships, and corporations.
  • Focus on high-income earners: The IRS has publicly stated its intention to prioritize audits for taxpayers earning over $400,000 annually. This shift aims to address concerns about fairness and ensure everyone pays their fair share of taxes.

In general, the chances of being audited by the IRS are quite low, averaging about 1 in 333, or 0.3% of tax returns. A large portion of these audits, approximately 74%, are conducted through correspondence, meaning most taxpayers will not have a face-to-face meeting with an IRS agent even if audited. This low rate of audits marks a continuing trend that began in 2010, and despite the growing number of tax returns filed, the IRS audited only a small fraction of them​​.

With so few returns inspected, how does the IRS decide who to target? While the selection process incorporates computer scoring models and risk analysis, numerous red flags can draw extra scrutiny.

Let’s examine some of the most common audit triggers.

#1. Mathematical Errors

One of the most basic red flags is submitting a tax return with clear math errors. Failing to add, subtract, or apply formulas correctly is an easy mistake but instantly raises questions.

The IRS has advanced software that quickly uncovers sloppy calculations, data entry errors, transposed numbers, or incorrect formulas pertaining to:

  • Tax liability
  • Taxable income
  • Adjusted gross income (AGI)
  • Refund/balance due
  • Supporting schedules

Double-check all numbers on your return, run totals manually, and use your own calculator to verify figures computed by software. Submitting balanced, accurate totals demonstrates good faith reporting and avoids math-based examination.

#2. Unreported Income 

#2. Unreported Income 

One central function of IRS audits is uncovering unreported or underreported income. If you receive tax statements like W2s and 1099s reflecting income you exclude from your tax return, it inevitably triggers scrutiny.

Audit risk also rises if your declared income seems insufficient to support your lifestyle based on large expenditures, lavish vacations, or luxury assets. Failing to report cash earnings like tips, side jobs or rental proceeds is another problem area.

Always disclose legitimate income sources accurately, including:

  • Investment returns
  • Wages
  • Self-employment revenue
  • Retirement plan withdrawals
  • Alimony
  • Lawsuit settlements
  • Prizes
  • Royalties
  • Digital currencies

Speak to experts in tax services to ensure full and accurate income reporting to avoid audit risk.

#3. Excessive Business Expense Deductions

#3. Excessive Business Expense Deductions

Another primary audit trigger is overstating business tax deductions. Small business filers are frequently targeted if unusual expense patterns appear aggressive or excessive relative to the entity’s size and revenue.

Take special care with:

  • Travel, meals & entertainment: Dining out and traveling are common areas of abuse.

Scrutiny intensifies when rules for deductibility are ignored like:

  1. Lacking detailed mileage logs.
  2. Missing receipts/proof of business purpose.
  3. Exceeding per diem rates.
  4. Including companions without justification.
  • Vehicle use: Large mileage deductions draw IRS attention, especially at higher income levels. You need to prove business transportation needs through contemporaneous mileage logs and demonstrate vehicle costs are actual expenses, not estimates.
  • Home office claims: Many solopreneurs and self-employed taxpayers take the home office deduction. However, improper implementation makes it a frequent audit trigger, so follow all rules.

When claiming tax deductions, remember — documentation is key! Maintain detailed records proving all business expenses are legitimate to avoid misstating deductions.

#4. Contribution Concerns

#4. Contribution Concerns

Taxpayers frequently take charitable deductions for donations to qualified nonprofits.

However, multiple issues can raise scrutiny:

  • Unusually high contributions: Deducting over 50% of AGI should include appraisals supporting property values. Higher-income taxpayers with substantial write-offs often face examination.
  • Documentation issues: Missing receipts for cash donations exceeding $250 or taking noncash deductions over $500 without form 8283 invites an audit.
  • Noncash asset valuations: Donated property like art, vehicles, or collectibles lacking qualified appraisals draws verification requests. Understatements cause tax change assessments.

With charitable claims consistently making the IRS's “Dirty Dozen” list of top problems, take extra care documenting any substantial contributions you claim.

Negative Income Tax Signs

Negative Income Tax Signs

While most taxpayers strive for refunds each spring, claiming credits generating tax overpayments can also increase audit risk, including:

  • Earned income tax credit (EITC): This refundable credit for lower-income working individuals frequently sees high improper payments. Expect IRS correspondence verifying children, income, residency, and filing status.
  • Child tax credit/additional child tax credit: These popular credits also draw IRS attention to ensure qualifying children, income thresholds and phaseouts apply. Having claimed children improperly in the past raises red flags.
  • Education credits: The American Opportunity and Lifetime Learning credits help offset college costs but the IRS targets them for ineligible students, expenses, or income levels. Failure to meet complex requirements for these and other credits provokes IRS scrutiny of eligibility.
  • Foreign assets or accounts: The IRS heavily focuses on international activity due to noncompliance risks, so holdings like:
  • Overseas financial accounts: Aggregates exceeding $10,000 must be reported each year on an FBAR statement with hefty penalties for failures.
  • Foreign retirement plans: Interests in foreign pensions or deferred compensation require annual form 8938 reporting.
  • Foreign trust interests: Foreign trusts holding over $50,000 in assets need declarations on form 3520.
  • Foreign corporations and partnerships: Ownership stakes meeting thresholds require Form 5471 or Form 8865 filings.

Failure to disclose offshore holdings, income, or gains can prompt substantial penalties beyond any additional tax deficiencies.

How to Minimize Your Audit Risk

How to Minimize Your Audit Risk

While no one enjoys extra tax notices or examinations, some taxpayers have much higher audit odds. 

Proper development of tax and inner audit strategies can help minimize unwanted IRS attention:

  • Report all income: Disclosing all taxable income sources completely and accurately avoids underreporting red flags.
  • Provide details on complex areas: Thoroughly explain special circumstances like hardship withdrawals, nontaxable exchanges, write-off details, contributions timing, virtual currency sales, hobby vs business classifications, and casualty loss claims.
  • Retain supporting documents: Keep tax records like donation receipts, mileage logs, invoices, 1099 forms, and income statements organized and accessible in case documentation is requested to resolve a question or substantiate a return position.
  • Claim tax breaks: Tax breaks, also known as tax deductions or credits, are provisions in the tax law designed to encourage certain behaviors or investments by reducing the amount of income tax an individual or business owes to the government. These can range from deductions for educational expenses, investments in renewable energy, contributions to retirement accounts, and expenses related to healthcare.

Why Expert Guidance Is Necessary for the Audit Process

Why Expert Guidance Is Necessary for the Audit Process

A certified public accountant, EA, or tax attorney can provide critical help navigating complex filing situations like foreign assets disclosures, alternative minimum tax exposure, self-employment leases, mergers and acquisitions, executive compensation, and many other intricate areas.

Lewis CPA has over 38 years of successfully representing individuals and businesses in IRS dealings, including managing correspondence, preparing responses, negotiating settlements, and securing the most favorable outcomes possible upon audit.

We tenaciously protect client rights and proactively advise reporting approaches mitigating IRS interest. Our expertise across filing, reporting, documentation, tax abatement requests, and complex technical areas allows for crafting tailored strategies so clients can run their enterprises or financial lives smoothly.

Tax Audit Outcomes: Possible Taxpayer Results

Tax Audit Outcomes: Possible Taxpayer Results

If you’re selected for review, here are some common audit outcomes to understand:

  • No changes: Examiners verify positions are properly supported under tax laws. You may simply receive a “no change” letter.
  • Adjustment/cash due: Inadequate documentation triggers revised liability requiring additional tax owed. Interest and penalties may apply.
  • Cash refund: If deductions or credits claimed improperly are reduced by auditors, any prior overpayment gets refunded to the IRS. No interest applies.
  • Request additional documentation: Extra forms, records, or clarifying statements commonly allow resolution without further proceedings. Providing requested items promptly is recommended.

Avoid the Pitfalls — Audit Help from Lewis CPA

Receiving an IRS notice feels concerning for any taxpayer. By understanding key risk areas that often trigger questions from the IRS or audits, you can thoughtfully assess your past returns with a critical eye, enable corrections minimally impactful financially or administratively, and implement prudent strategies to reduce further inquiry risks.

Contact Lewis CPA today for a free consultation or tax return checklist so we can evaluate your prior submissions, and overall planning, and quickly self-correct any areas potentially prompting IRS attention. Our goal is to avoid unnecessary headaches for clients through smart, customized tax preparation and representation guidance.

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