15 Actions That Will Put You on the IRS Radar

Ever feel like the IRS has a personal vendetta against you or someone you know? You’re not alone. If you’ve ever been on the receiving end of a dreaded audit notice, you might have wondered what exactly put you on the radar. It turns out it’s not just bad luck or a cosmic conspiracy; certain triggers significantly increase the likelihood of an audit. Certain situations predispose you to a ‘friendly chat’ with the IRS. Consider this your guide to understanding—and hopefully avoiding—the 15 most common audit triggers.

High Income

For no fault of theirs, taxpayers with significantly higher incomes face a greater chance of being audited by the IRS. This is because larger incomes often come with more complex financial situations and a higher probability of discrepancies. The IRS allocates more resources to examine high-income earners since even minor errors can lead to substantial differences in tax revenue.

Mathematical Errors

Flimsy and simple arithmetic mistakes on tax returns can prompt an IRS audit. When numbers don’t add up correctly, it raises suspicion and signals potential underlying issues. The IRS uses automated systems to check for these errors, and even minor miscalculations can trigger further review. Software tools or professional tax preparers can be beneficial in minimizing the risk of such errors.

Unreported Income

Failing to report all income, especially when it has been documented by third parties such as employers or financial institutions, is a major red flag for the IRS. The agency receives copies of all W-2s, 1099s, and other income reports, and discrepancies between these documents and your tax return can quickly lead to an audit.

Excessive Deductions

While legitimate deductions are allowed, those that seem disproportionate to your income level may be questioned. Claiming suspiciously high deductions compared to your income can attract IRS attention. This includes deductions for business expenses, charitable contributions, medical expenses, and more. It’s important to keep detailed records and receipts to substantiate any claims.

Business Losses

Keeping comprehensive records and documentation to prove that the business is being operated with the intent to make a profit is essential for avoiding audits. The IRS differentiates between genuine business ventures and hobbies that generate losses primarily for tax benefits. If a business shows losses year after year, the IRS may investigate to determine if it’s a legitimate business or if expenses are being improperly claimed.

Cash Businesses

Due to the reputation for underreporting income, businesses that primarily deal in cash, such as restaurants, retail stores, and bars, are at a higher risk for audits. Accurate and meticulous record-keeping is vital for cash-based businesses to ensure all income is reported. The IRS may use indirect methods, such as comparing industry averages and analyzing lifestyle against reported income, to identify discrepancies in these businesses.

Foreign Accounts

Taxpayers with offshore accounts must file the necessary forms, especially the Foreign Bank Account Report (FBAR), and include all relevant income on their tax returns. Evading the reports on foreign bank accounts or income from abroad can significantly increase the risk of an audit. The IRS has stringent reporting requirements for foreign assets and income, and non-compliance can lead to severe penalties.

Home Office Deductions

The IRS has strict criteria for these deductions, requiring that the space be used exclusively and regularly for business purposes. Any deviation from these rules can attract scrutiny. Taxpayers should ensure they meet all qualifications for claiming a home office and keep detailed records and evidence of the space’s business use.

Self-Employment Income

Self-employed individuals are also prime on the IRS radar due to the greater likelihood of underreporting income and overreporting deductions. The lack of third-party verification means the IRS scrutinizes these returns more closely. Maintaining detailed and current records of all income and expenses, using professional and reliable accounting practices, can help self-employed taxpayers stay compliant and minimize audit risks.

Inconsistent Reporting

Inconsistencies in your tax returns, whether from year to year or between your tax return and other financial documents, can trigger an audit. Discrepancies in reported income, deductions, or filing status can raise red flags. Review your tax returns for inconsistencies and ensure accuracy across all documents, such as W-2s, 1099s, and bank statements.

Rental Property Deductions

Owning rental properties offers valuable tax deductions, but incorrectly claiming or calculating these can increase audit risks. Issues include misallocating personal and rental use expenses, failing to report all rental income, or claiming excessive depreciation.

Charitable Contributions

While philanthropy is noble, there are some who use it as a front for tax evasion because charitable donations offer tax deductions. Improper claims or documentation can lead to an audit. Issues include inflating non-cash donation values, lacking proper documentation, or claiming ineligible contributions.

Large Cash Transactions

Banks and financial institutions report transactions over $10,000. Even if legitimate, frequent large cash deposits or withdrawals can lead to suspicion and prompt an audit. To avoid this, keep detailed records of all large cash transactions, including the purpose and source of the funds. If you’re a business, use cash transaction reports to document large transactions.

Frequent Stock Trades

Active trading in the stock market can draw IRS scrutiny due to the complexity of reporting capital gains and losses. The IRS wants to ensure that all trades are accurately reported and that the correct taxes are paid on profits. Keeping detailed records of each trade, including purchase dates, costs, sales proceeds, and any associated fees, is essential.

Cryptocurrency Transactions

Contrary to uninformed opinions, the IRS can track cryptocurrency transactions. The IRS has laser focus on cryptocurrency transactions as digital currencies have become more widespread. Transactions involving Bitcoin and other cryptocurrencies must be reported, including trades, sales, and income from activities like mining or staking. Failing to report these transactions accurately can trigger an audit.