Some taxpayers believe that being audited by the Internal Revenue Service (IRS) means the agency thinks you’ve committed a crime, which isn’t true. IRS audits can be random or can be caused by automatically reviewed discrepancies. While you can’t always prevent an audit, there are some high-risk behaviors and transactions that can increase the chances of being audited. With tax season just around the corner, many taxpayers wonder, “What triggers an IRS audit?”
Why Does the IRS Conduct Audits?
Each year, the IRS conducts thousands of audits to investigate whether taxpayers are meeting their obligations and reporting all taxable income and assets. An audit may mean a taxpayer owes the IRS more in taxes, or there may be no change made. The IRS closed 505,514 audits on tax returns in 2024, nearly 394,000 of which were conducted through the mail. These examinations led to more than $29 billion in recommended additional tax.
It can be scary to receive a notice for an IRS audit, but it can help to understand how the IRS selects taxpayers for an examination. There are three main reasons:
- Random selection: Some taxpayers are randomly selected for an IRS audit.
- Computer screening: There are automatic computer screenings that place taxpayer returns against the norm for the year, and this screening may detect an error or other discrepancy.
- Related transactions: You had business transactions or other financial interactions with another taxpayer who was audited for either of the above reasons.
An audit is a routine process, and often it is easy to correct an error made on your taxes or pay a required fine for a mistake. Unfortunately, audits can also have more serious consequences.
While it’s true that receiving notice of an audit doesn’t automatically mean the IRS thinks you did something illegal, that doesn’t mean you should take the audit process lightly. Criminal investigations are rare, but they are an important part of IRS compliance presence. Sometimes, an audit can lead to criminal consequences or an investigation. There were 2,667 criminal investigations launched in 2024.
Common Red Flags for Audits
There are some financial actions or errors that increase the chances that the IRS will audit your taxes. Some of these are errors you can address in advance by getting the right professional support to prepare your taxes. Other red flags are harder to address, and it is better to prepare an effective audit defense. Some common red flags that can lead to IRS audits include:
Underreported Income
If you fail to report all of your income, this can lead to an audit. Institutions that pay your income, whether that is your employer directly or a third-party service, report that income. If there are discrepancies between the income reported by other parties and the income you report, this will likely be flagged.
While this can be an easy mistake to avoid, it is also very common. You are even more likely to make these errors if you have numerous income sources or when income sources do not withhold taxes like wages or salaries do.
Business Expenses
When you run a business, you can take certain deductions for business expenses. However, if you take excessive deductions, this can be a red flag for the IRS. Travel expenses or business use of a vehicle are some of the most common excess-deductions by business owners and others who are self-employed. The IRS also takes notice of high use of credits by businesses.
If travel or other deductions are outside the norm, you claim your only vehicle as a business deduction, or you excessively use the research and development credit, this can lead to an audit.
Significant Deductions or Credits
Even if you are not a small business or self-employed, taking deductions, credits, or losses outside the typical norms can also trigger an audit. This can include significant credits for charitable donations that are disproportionate to your income level or taking the healthcare premium tax credit despite having a high income. Child-related tax credits can also lead to mistakes and the potential for audits.
However, this doesn’t mean you should avoid taking valid credits and deductions. It’s important to have documentation of them to prove them to the IRS.
Undervaluing Assets
The IRS also looks out for undervalued assets on estate tax returns. The agency has resources to evaluate property like real estate, businesses, or other expensive personal property. It’s important to accurately evaluate the price of these items when they are part of your taxes and have proof of that appraisal.
Failing to Report Foreign Accounts
When you have a foreign bank account, there are very strict requirements for reporting it and its value. Audits are especially likely for accounts in countries considered to be tax havens, where US taxpayers hide income. When you have a foreign account, you have to provide significant information to the IRS. If you don’t report it, you can face serious consequences.
High Income
The IRS is more likely to audit taxpayers with higher incomes. In 2022, the IRS audited about 0.1% of tax returns for each income range between $50,000 to $500,000 for individual income returns, but audited the following percentage of other individual income returns:
- 0.6% of returns for those earning between $500,000 and $1 million
- 1.1% of returns for income of $1 million to $5 million
- 3.1% of returns on income of $5 million to $10 million
- 4.0% of returns for those earning $10 million or more
When this income is from a business, the likelihood of an audit is even higher. While having a high income is not an error that you can or should fix, it is important to be aware of it so that you are prepared to deal with an IRS audit.
Income Changes
If you see major changes each year in your income, this may increase the chances of an audit. This is more common for those who are self-employed and own businesses. The IRS may want to assess the potential for underreported income.
Hobby Losses
When you write off significant business losses year after year, the IRS may consider it a red flag and assume you are writing off losses to hobbies. This is even more likely if you have income from other sources or if the business expenses are for a sole proprietorship. While business losses happen, the IRS may audit to determine why a business does not create a profit.
Cryptocurrency Transactions
Cryptocurrency and other digital transactions are often used to hide income, so the IRS has increased its scrutiny of any transactions using virtual currency. You could face an audit for these transactions, especially if you violate the reporting requirements for these financial actions.
FAQs About What Triggers an IRS Audit
Does an IRS Audit Mean You Did Something Wrong?
No, an IRS audit does not mean you did something wrong, and it doesn’t mean the IRS suspects anything criminal. Audits are a routine method the IRS uses to check the accuracy of taxpayers’ financial information and tax payments. However, audits can uncover issues that lead to penalties, higher tax payments, or even criminal consequences in rare cases. You should still take them seriously and prepare appropriately for them.
What Is a Common Red Flag that May Trigger an IRS Audit?
There are several common red flags that can lead to an IRS audit, such as low-valued assets, failing to report all your income, or taking extremely high deductions or credits.
Other red flags include being inconsistent when filing your tax forms, having international income or accounts that you don’t report properly, cryptocurrency transactions, or having any sort of business dealings with another taxpayer who is audited. Audits can also occur if you have had a poor history of tax compliance.
How Important Is Audit Defense?
An audit defense is very important, even if you think you’ve done nothing wrong. A defense helps you avoid errors and makes sure that your rights are protected. An IRS agent is looking out for the interests of the agency. Getting an audit defense helps look out for your interests. The right professional can also assess your taxes prior to an audit, and preemptively address any mistakes. If you are assessed a higher tax, a professional can help with an appeal.
Why Do You Need to Hire a Tax Lawyer for an Audit?
It helps significantly to hire a Jacksonville IRS tactics lawyer if you are being audited to protect your interests and get legal advice about your specific situation. A tax lawyer can review your tax and financial information, fix mistakes before an audit, and help you prepare for the audit itself. They represent your interests to the IRS. If the audit determines that you owe more in taxes, your attorney assesses the next steps, such as an appeal or other option.
Getting the Right Defense for Your IRS Audit
If you receive a notice for an IRS audit, you need to get the support of an experienced tax law and IRS attorney. The right legal support helps you take preemptive action to gather documentation, prove credits and deductions, and protect your rights from the IRS.
At TaxSmith, LLC, we have decades of experience in tax codes and know how to deal with IRS agents during audits. Reach out to our firm today and let us bring you comprehensive and transparent legal guidance.
