How Likely Are You to Get Audited by the IRS?

An IRS audit is a review of an individual’s or organization’s financial information and accounts to ensure accuracy and compliance with tax laws. Understanding the factors that influence audit selection and the different types of examinations can help taxpayers navigate their tax obligations.

Overall Audit Statistics

The likelihood of an individual tax return being audited by the IRS remains low. For the 2020 tax year, only 0.2% of individual income tax returns faced an audit. This general audit rate has declined in recent years, partly due to a reduction in the IRS workforce.

Audit rates vary significantly across different income levels. Taxpayers with annual incomes below $25,000 have faced higher audit rates compared to middle-income brackets. This is often due to the IRS focusing on the Earned Income Tax Credit (EITC), which historically has a higher audit rate because of its complexity and potential for error.

Conversely, taxpayers with very high incomes, particularly those earning over $10 million, typically experience the highest audit rates. Despite this, audit rates for millionaires have also seen declines in recent years, though the IRS aims to increase scrutiny on high-income taxpayers and large corporations in the future.

Factors Increasing Audit Likelihood

Certain aspects of a tax return or a taxpayer’s financial situation can increase the probability of an IRS audit. High-income individuals often face increased scrutiny due to the complexity of their financial arrangements and the potential for larger tax discrepancies. Large swings in reported income that cannot be easily explained by W-2s or 1099s can also draw attention.

Self-employed individuals and small business owners who file Schedule C, Profit or Loss from Business, generally experience higher audit rates. These returns offer more opportunities for deductions and the potential for underreporting income or overstating expenses. The IRS is particularly attentive to excessive business expenses, home office deductions, or vehicle usage claims that seem disproportionate to the business’s income or industry norms.

Large or unusual deductions can also trigger an audit. Deductions that appear disproportionately high compared to a taxpayer’s income, such as significant charitable contributions, can raise questions. Extensive or vague travel and entertainment expenses are often scrutinized due to strict recordkeeping requirements.

Rental income and losses, reported on Schedule E, Supplemental Income and Loss, can also be a point of focus. The IRS examines passive activity losses, which generally limit the deduction of losses from passive activities, including most rental real estate, to offset only passive income. Claiming substantial rental losses, especially if not offset by passive income, or attempting to deduct them against active income without qualifying as a real estate professional, can lead to an audit.

Foreign bank accounts and assets are another area of increased IRS attention. U.S. persons with a financial interest in or signature authority over foreign financial accounts with an aggregate value exceeding $10,000 must file a Report of Foreign Bank and Financial Accounts (FBAR), FinCEN Form 114. Certain U.S. taxpayers holding specified foreign financial assets above specific thresholds must also report them on Form 8938, Statement of Specified Foreign Financial Assets, under the Foreign Account Tax Compliance Act (FATCA). Failure to file these forms accurately or at all, or discrepancies between reported information and data received by the IRS from foreign financial institutions, can lead to penalties and audit triggers.

Cryptocurrency transactions have become a significant focus for the IRS. Taxpayers must report all taxable events involving digital assets, including sales, trades, and income from mining or staking. Unreported crypto-to-crypto trades, large or frequent transfers between wallets and exchanges, or the use of privacy-focused coins can attract IRS attention. Accurate reporting of capital gains and losses on Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses, is required.

Claiming certain refundable tax credits, such as the Earned Income Tax Credit (EITC) or significant education credits, has historically led to higher audit rates. The potential for improper claims makes them a frequent target for IRS review.

Finally, not reporting all income is a major red flag. The IRS receives copies of W-2s, 1099s, and other information returns from employers, banks, and other payers. If the income reported on a tax return does not match the information the IRS has on file, it will likely trigger an automated notice or an audit.

IRS Return Selection Process

The IRS employs various methods to select tax returns for audit, combining automated systems with human review. One primary method involves computerized scoring systems, such as the Discriminant Function System (DIF). This system analyzes tax returns and assigns a score based on the likelihood of a tax change if the return were audited. Returns with high DIF scores are flagged for further review by IRS personnel, who then decide which returns warrant an actual audit.

Information matching is another significant component of the selection process. The IRS compares information reported by taxpayers on their returns with data received from third parties, such as employers (W-2s), banks (1099-INT, 1099-DIV), and brokers (1099-B). Discrepancies between these sources, such as unreported income or missing forms, can automatically trigger a notice or an audit.

A small percentage of returns are selected randomly as part of the National Research Program (NRP). These audits gather data on taxpayer compliance across different income levels and types of taxes, helping the IRS update its selection models and focus its resources.

Whistleblower tips can also initiate an audit. Individuals who provide specific and credible information about tax law violations can submit a Form 211, Application for Award for Original Information, to the IRS Whistleblower Office. These tips can lead to audits targeting various forms of tax fraud or underpayment.

Finally, related examinations can result in an audit. If one taxpayer’s return is selected for audit, the IRS may also examine returns of other individuals or entities involved in transactions with that taxpayer, such as business partners, investors, or related businesses.

Types of IRS Audits

Should a tax return be selected for examination, the IRS conducts audits in several forms, each with varying levels of intensity and scope. The type of audit depends on the complexity of the issues identified and the amount of documentation required. The IRS will always notify taxpayers of an audit by mail, not by phone.

The simplest and most common type is a correspondence audit. These audits are conducted entirely by mail and usually address minor issues or discrepancies, such as missing documentation for a specific deduction or a mismatch in reported income. The IRS sends a letter requesting additional information or clarification, and the taxpayer responds by submitting the requested documents.

For more complex issues, the IRS may conduct an office audit. These audits typically involve an in-person meeting at a local IRS office, where the taxpayer brings specific supporting documents for review. Office audits are generally used for individual returns with more involved questions or small business returns.

The most comprehensive type of examination is a field audit. These audits are conducted by a revenue agent at the taxpayer’s home, place of business, or the office of their representative. Field audits are typically reserved for complex individual returns, large business returns, or situations requiring a thorough review of financial records and operations.