Dear Clients,
Understanding what may increase your chances of being audited can help you avoid costly mistakes and prepare proper documentation if the IRS comes knocking. The IRS audits less than 1% of all individual returns—but certain “red flags” dramatically increase the odds.
Here are the key triggers and tips to help you stay in the clear:
🚩 Top Red Flags on Individual Returns
High-Income Filers: The higher your income, the higher your risk. Audits jump significantly for those earning over $500,000, and especially over $1 million.
Large Deductions or Credits:
o Charitable Deductions disproportionate to income.
o Education Credits (especially the American Opportunity Tax Credit).
o Earned Income Tax Credit (EITC) errors are frequent and trigger many audits.
Filing Paper Returns: Math errors are more common on paper. E-filing with software reduces mistakes and red flags.
Schedule C Filers (Self-Employed): The IRS scrutinizes sole proprietors due to common income underreporting and inflated expenses.
Claiming a Home Office: Strict rules apply. The space must be used exclusively and regularly for business.
Cash-Intensive Businesses: Hair salons, bars, restaurants, etc., are considered higher risk due to potential unreported income.
Rental Losses: Unless you're a qualified real estate professional, deducting rental losses is limited to passive rental income.
Day Trading as a Business: Most investors should not report trading on Schedule C unless they meet strict IRS criteria.
Gig Economy & Digital Assets:
o Income from platforms like Uber, Airbnb, Venmo, and PayPal must be reported.
o Digital currency transactions (crypto, NFTs) are a growing focus area for the IRS.
Foreign Accounts: Failure to file FBAR (FinCEN 114) or Form 8938 for offshore accounts can lead to steep penalties.
Unusual Income Drops: Sudden decreases from prior years can trigger scrutiny.
Claiming 100% Business Use of a Vehicle: Rarely justified without strong documentation.
Alimony or Child-Related Discrepancies: IRS matches returns of both parties in divorce cases—mismatches raise flags.
🏢 Red Flags for Entities (S Corps, Partnerships, and Corporations)
Large Asset Base: The larger the corporation’s assets, the higher the audit risk.
Flow-Through Entities: Partnerships and S corps face extra attention, especially with complex ownership or significant losses.
Unusual Deductions or Losses: Excessive business credits, losses, or inconsistencies between entity and shareholder returns can trigger a deeper dive.
💡 Pro Tips to Stay Prepared
File electronically.
Report all income, even from small side gigs, crypto trades, or casual sales.
Maintain detailed records: Especially for business expenses, donations, vehicle use, or travel deductions.
Review IRS correspondence carefully: Initial audit contact is always by mail—not phone or email.
📈 Looking Ahead
The IRS workforce has been decreased by 25% and the administrations current budget proposal recommends an additional 20% reduction in IRS funding next year. Now is a great time to review your records and ensure compliance.
If you have questions about your return or want a risk review, feel free to reach out. We're here to help you avoid red flags and stay audit-ready.