Why Do Audits Happen? The Most Common Tax Audit Triggers

Tax audits are a routine part of the tax system, representing a review of financial information to ensure accuracy and compliance with tax laws. They serve to maintain fairness and integrity across the taxpayer base. Receiving an audit notice does not automatically imply wrongdoing or an error on your part. Instead, it often indicates that your return has been selected for a closer look based on specific criteria or even random chance.

Computerized Selection and Randomness

A significant number of tax audits begin with computer programs employed by tax authorities. These systems, such as the Discriminant Information Function (DIF) system, analyze tax returns for unusual patterns or inconsistencies. Each return receives a score, with higher scores indicating a greater potential for changes to tax liability, making them more likely candidates for an audit.

Alongside these data-driven methods, some tax returns are chosen by random selection. This practice ensures general compliance across all taxpayer segments, regardless of specific flags. While a statistically small percentage of returns are selected this way, it means any taxpayer could be audited without prior indication of an issue. These random audits also help the IRS update its statistical models and “norms” for future selections.

Mismatched Information

Discrepancies between income or deduction information reported by taxpayers and information submitted by third parties to the tax authority commonly lead to audits. The IRS operates information matching programs that cross-reference data from various sources with your tax return. This automated comparison is effective at identifying issues.

Common examples of such mismatches include income reported on W-2 forms from employers or various 1099 forms (e.g., 1099-INT, 1099-DIV, 1099-B, 1099-MISC/NEC) that doesn’t align with taxpayer reports. K-1 forms from partnerships or S corporations showing different income or loss amounts than reported on personal returns can also trigger scrutiny. If these numbers do not match, the system flags the return for review, often leading to a notice of discrepancy.

Unusual or High Deductions

Certain deductions, credits, or expenses that appear unusually high for a taxpayer’s income level or profession can attract attention. While legitimate, these deviations from statistical norms may prompt examination to verify validity. Tax authorities compare your claims against averages for similar returns to identify outliers.

Examples include large Schedule C losses, especially for businesses that might resemble hobbies rather than for-profit ventures. Excessive home office deductions or vehicle expenses that seem disproportionate to the nature of the business can also raise red flags. Unusually high charitable contributions compared to income, or itemized deductions disproportionate to adjusted gross income (AGI), often lead to inquiries. Claiming credits without meeting all eligibility criteria, such as the Earned Income Tax Credit (EITC), is another common trigger.

Tips and Other Data Sources

Audits can also be initiated by information from external sources. Whistleblowers, for instance, can report suspected tax evasion, and if the information is deemed credible, it may lead to an investigation. Other government agencies, including state tax authorities or foreign governments sharing financial information under international agreements, can provide data that prompts an audit.

Specific types of transactions are more likely to draw scrutiny. Large cash transactions over $10,000 often require specific reporting (e.g., Form 8300) and can attract attention, especially if they do not align with a taxpayer’s reported income. Unreported foreign bank accounts or assets, such as those requiring a Report of Foreign Bank and Financial Accounts (FBAR) for values over $10,000, are a focus for tax authorities combating offshore tax evasion. Transactions involving complex financial instruments or offshore entities also tend to be reviewed more closely due to their intricate nature and potential for non-compliance.