As a taxpayer, you may wonder what amount of income or deductions reported on your tax return might trigger an audit by the Internal Revenue Service (IRS). While there is no definitive threshold that automatically leads to an audit, there are certain red flags that could increase your chances of being audited.
IRS Audit Rates
In general, the IRS audits only a small percentage of tax returns each year. For example, in Fiscal Year 2022, the IRS audited around 0.45% of all individual tax returns. This percentage varies based on income level:
| Adjusted Gross Income | Audit Rate |
|---|---|
| Less than $25,000 | 0.31% |
| $25,000 to $200,000 | 0.53% |
| More than $200,000 | 1.10% |
As you can see, audit rates increase as income rises. However, the vast majority of returns are not audited, even among higher-income taxpayers.
Red Flags for Individual Taxpayers
While the IRS does not disclose exactly what triggers an audit, experts agree there are certain factors that seem to increase the odds. Here are some of the biggest red flags:
High Business Expenses
If you report a high amount of business expenses or claim the home office deduction as a self-employed taxpayer, this could invite scrutiny. Business deductions typically need thorough documentation, so a disproportionately large write-off compared to your income is likely to prompt the IRS to verify your expenses.
Unreported Income
The IRS receives copies of Forms W-2 and 1099 reporting your income from your employer, bank, or other payers. If you fail to include all your 1099s or W-2 income on your return, the IRS computers will flag this discrepancy right away. Always make sure you have declared all sources of taxable income.
Large Charitable Donations
Because charitable contributions provide a tax deduction, large donations tend to get extra attention from the IRS. A good rule of thumb is to make sure your charitable deductions are less than 60% of your adjusted gross income. Larger amounts could raise questions.
Cryptocurrency Activity
The IRS treats virtual currencies like bitcoin as property for tax purposes. That means you have to report any gains or losses from sales or exchanges of cryptocurrencies. With crypto tax rules still relatively new, many taxpayers inadvertently fail to report their virtual currency transactions or do it incorrectly. This oversight can trigger an audit.
Math Errors
Simple math mistakes are one of the most common reasons for IRS correspondence. Double-check your return to make sure all your calculations, such as totals and balances, are correct. Even small errors can prompt the IRS to take a closer look.
Foreign Assets or Accounts
If you have foreign bank accounts, retirement accounts, businesses, trusts, or other assets, you may have to file additional IRS forms such as the Report of Foreign Bank and Financial Accounts (FBAR). Failing to report offshore activity or income can result in steep penalties and increased audit potential.
Items Most Frequently Audited
While the IRS looks at tax returns as a whole, there are certain deductions, credits and income amounts that tend to be audited most often. These include:
| Audit Item | Details |
|---|---|
| Business meals/travel | Must have detailed documentation of amount, time, place, business purpose |
| Cell phone, utilities | Must show business vs. personal allocation |
| Home office deduction | Must meet exclusive business use tests |
| Hobby vs. business | Must show profit motive if claimed as business |
| Bartering income | Must report fair value of goods/services bartered |
| Rental property income/expenses | Must differentiate between rental and personal use |
| 401(k), IRA contributions | Must avoid excess contributions over the annual limits |
| Education credits | Must document eligibility for American Opportunity or Lifetime Learning Credits |
| Earned Income Tax Credit | Must have qualifying child and meet income limits |
Keeping thorough documentation can help avoid issues if any of these frequently-audited items are questioned by the IRS.
Red Flags for Business Tax Returns
Business returns, especially from partnerships and S corporations, have higher audit odds than individual taxpayers. Some items that can attract IRS scrutiny include:
Losses
Reporting heavy losses year after year raises red flags, unless the business can demonstrate it is taking meaningful steps to improve profitability. The IRS may investigate to see if the activity is a legitimate business rather than a hobby or tax shelter.
Industry Averages
If your gross profit margin, expenses as a percentage of income, or other ratios fall far outside industry norms, the discrepancies could trigger an audit. Be prepared to explain any outliers.
1099 Matching
Just like for individuals, the IRS matches 1099 forms reported by your business against what is on your return. Omitting 1099 income is likely to generate an audit notice.
Employee Classification
Treating workers as independent contractors rather than employees can save payroll taxes but requires proper classification. If workers seem misclassified, the IRS may investigate your business for payroll tax evasion.
Business Credits
Generous tax credits like the Research and Development Credit or Work Opportunity Credit will be reviewed to ensure your business qualifies for them and has the documentation to back up the credit amount claimed.
Top Audit Triggers
While every tax return has its own unique factors, these are among the biggest red flags that could increase your audit odds:
- Unreported income
- Discrepancies between forms like 1099s/W-2s and your reported income
- Very high business expenses or charitable deductions compared to income
- Math errors
- Losses year after year if operating a business
- Foreign assets or offshore activity
- Suspicious deductions like home office or travel expenses
Strategies to Avoid Audit
While there is no foolproof way to avoid an IRS audit completely, you can reduce your chances by:
- Reporting all your income accurately
- Keeping thorough documentation for deductions and credits claimed
- Checking for errors before filing
- Being conservative with expense deductions and write-offs
- Not offsetting too much income with deductions
- Reporting any foreign assets, accounts or income
Including these tips in your tax preparation strategy can help minimize audit risk and keep your tax return clean in the eyes of the IRS.
What to Do in an Audit
If you do receive that dreaded letter from the IRS saying you are being audited, stay calm. Not all hope is lost. Here are some tips on surviving an audit:
- Read the notice carefully to determine what the IRS is questioning.
- Gather up any related documentation you have to support the return.
- Consider hiring a tax professional to represent you.
- Be polite and professional with the auditor.
- Don’t volunteer extra information beyond what is requested.
- If errors are found, accept responsibility and pay any additional tax owed promptly.
While being audited is stressful, showing you have a reasonable basis for the numbers on your return can help resolve many audits without excessive hassle.
Conclusion
Being audited by the IRS is a low probability for most taxpayers, but higher incomes or suspicious deductions can increase your risk. Keeping thorough records provides the best defense if your return is questioned. By understanding the most common audit triggers, taxpayers can practice proactive strategies to avoid raising IRS eyebrows down the road.