What Are the Common Triggers for an IRS Audit?

The Internal Revenue Service (IRS) conducts audits as a review or examination of an individual’s or organization’s financial records. The purpose of an IRS audit is to ensure that the information reported on a tax return is accurate and complies with federal tax laws. This process verifies that taxpayers have correctly reported their income and claimed only the deductions and credits to which they are legally entitled.

An audit serves as a tool to maintain the integrity of the tax system and promote voluntary compliance among taxpayers. It does not automatically imply wrongdoing or that a taxpayer has intentionally made an error. The IRS selects returns for audit through various methods, including random selection, statistical formulas, and sometimes due to issues identified in related examinations of other taxpayers.

Discrepancies and Mismatches

Inconsistencies between a taxpayer’s return and information reported by third parties frequently trigger IRS scrutiny. The IRS employs an information matching program that compares data submitted by employers, financial institutions, and other entities with what taxpayers report on their returns. This system helps identify discrepancies that may indicate underreported income or overstated deductions.

For example, the IRS receives W-2 forms from employers detailing wages, salaries, and taxes withheld. Financial institutions provide 1099 forms for interest, dividends, and proceeds from stock sales. Independent contractors and gig economy workers often receive 1099-NEC or 1099-MISC for nonemployee compensation.

Any mismatch where the income reported on these third-party forms does not align with the income declared on the tax return can raise a red flag. If a taxpayer omits a 1099 form or reports a different amount than what the IRS has on file, it can lead to an automated notice or an audit. Accurately transcribing all income documents onto the tax return is a fundamental step in avoiding these common triggers.

Simple mathematical errors or transposed numbers on a tax return can also prompt an IRS inquiry. While minor errors are corrected through automated processes, significant calculation mistakes can trigger a more formal review. Incomplete forms or omitted schedules, such as failing to attach a required Schedule C for business income or a Schedule A for itemized deductions, signal that the return may not be fully compliant.

Furthermore, inconsistencies across different parts of the same tax return can draw attention. For instance, if figures on one schedule contradict information provided on another, it suggests a potential error or misrepresentation. Reviewing the entire return for accuracy before filing is a proactive measure taxpayers can take to prevent these discrepancies.

High-Risk Deductions and Credits

Certain deductions and tax credits are frequently scrutinized by the IRS due to their complexity or potential for abuse. These areas often require robust documentation to substantiate claims. Taxpayers should maintain detailed records to support any deductions or credits taken, especially those that deviate significantly from typical amounts for their income level.

Excessive business expenses claimed by self-employed individuals on Schedule C are a common audit trigger. The IRS closely examines large home office deductions, particularly if they appear disproportionate to business activity or if the space is not used exclusively for business. Vehicle expenses, travel, meals, and entertainment deductions are also frequently reviewed.

Large charitable contributions, especially non-cash donations, relative to a taxpayer’s income can invite scrutiny. Non-cash contributions often necessitate appraisals and detailed documentation for higher values. The IRS looks for proper substantiation to ensure the fair market value of donated property is accurately assessed.

The Earned Income Tax Credit (EITC) is another credit that is a frequent target for audits due to its complexity and high rate of improper payments. Eligibility for the EITC depends on factors like income, filing status, and qualifying children. Taxpayers claiming the EITC should ensure they meet all criteria.

Deductions that significantly reduce taxable income, particularly for higher earners, can also attract IRS attention. When deductions bring a taxpayer’s taxable income close to zero, it may prompt the IRS to verify the legitimacy of these claims. This is especially true if deductions appear unusually high compared to income or industry averages.

Significant or continuous losses from rental properties, reported on Schedule E, can also be a trigger. The IRS may question whether the property is genuinely held for investment or business purposes. Substantial rental losses can prompt an audit to ensure compliance with regulations.

Income Reporting Irregularities

Issues related to how income is reported, particularly from less traditional or easily verifiable sources, can lead to IRS audits. Comprehensive reporting is increasingly important for all taxpayers.

Unreported income from freelance work, gig economy activities, or cash-intensive businesses is a common area of IRS focus. Many gig economy platforms or small cash businesses may not always issue 1099 forms, or individuals may mistakenly believe certain income is not taxable. All income, regardless of source, is generally taxable and must be reported.

Businesses primarily dealing in cash, such as restaurants, salons, or small retail shops, face increased scrutiny. Cash transactions make it more challenging for the IRS to verify reported income, leading to a higher likelihood of audit.

The IRS has also significantly increased its focus on cryptocurrency transactions. Unreported gains or losses from buying, selling, or exchanging virtual currencies can trigger an audit. Taxpayers engaging in cryptocurrency activities are required to report these transactions accurately.

Reporting requirements for foreign financial accounts and assets are another area of increased enforcement. U.S. persons with financial interests in foreign financial accounts may need to file a Report of Foreign Bank and Financial Accounts (FBAR) if the aggregate value exceeds $10,000. Additionally, certain individuals may need to file Form 8938 with their tax return if asset values exceed specific thresholds. Failure to comply with these reporting requirements can lead to penalties and trigger an audit.

Other Common Triggers

Several other scenarios can lead to an IRS audit. These triggers often involve actions or financial profiles that deviate from typical patterns.

Filing an amended tax return, Form 1040-X, can sometimes draw attention from the IRS. An amended return, especially one that significantly changes the tax liability, may prompt a review. The IRS may want to understand the reasons for the changes.

Individuals with very high incomes are subject to increased scrutiny. The complexity of their financial affairs means that high-income filers are statistically more likely to be audited.

A taxpayer’s prior audit history can also influence the likelihood of a future audit. If a taxpayer has been audited before and significant issues were found, they might be more likely to be audited again.

Excessive itemized deductions reported on Schedule A, particularly when they appear unusually high compared to a taxpayer’s income level or national averages, can trigger an audit. This includes deductions for medical expenses, state and local taxes, and home mortgage interest.

Finally, reporting large capital gains or losses, particularly those involving complex transactions or unusually large losses, can also be a trigger. The IRS may review these transactions to ensure proper reporting. This is especially true for transactions involving less common investments.