In 2022, taxpayers filed over 164 million tax returns with the Internal Revenue Service (IRS). Of those, 626,204 were audited. Taxpayers with incomes greater than $10 million may be targeted more frequently for review. Some audits are random, while a taxpayer's actions may trigger others. Belowis a list of red flags that can flag a tax return for review.
Key Takeaways
- Overestimating home office expenses and charitable contributions are red flags to auditors.
- Simple math mistakes and failing to sign a tax return can trigger an audit and incur penalties.
- Taxpayers should report all income from Form W-2, Form 1099, and any cash earnings.
- Small business owners and limited partnership participants are at greater risk of an audit.
1. Overestimating Charitable Contributions
The IRS encourages individuals to donate clothes, food, and even used cars as charitable contributions by offering a deduction in return for a donation. Generally, the IRS likes to see individuals determine the fair market value (FMV) of donated items.
The taxpayer can use several methods to ensure donated goods are valued at a "fair" price. An appraisal is required for individual items valued at $5,000 or more, and taxpayers must complete Form 8283. The IRS also uses a willing-buyer-willing-seller test where taxpayers value their donated goods at a price where a willing seller would sell his property to a willing buyer.
2. Math Errors
While this may sound simple, many returns are selected for audit due to basic mathematical mistakes. Taxpayers should review their returns completed by an accountant to ensure the numbers are correct and check calculations for capital gains, paid interest and taxes, and tax credits.
3. Failing to Sign the Return
Failure to sign the return may incur additional scrutiny and a penalty. Individuals who are paid to prepare a federal tax return must have a validPreparer Tax Identification Number or PTIN. Paid preparers must sign and include their PTIN on the return.
4. Under-Reporting Income
All monies received throughout the year from work or the sale of an asset, such as a home, must be reported to the IRS. Failing to report income may incur back taxes plus penalties and interest.
If an individual accepts cash for a service they've performed and the payer is audited, the IRS may track the cash disbursem*nt from the bank account to the paid individual. Employers commonly provide income statements using Form W-2 or Form 1099. However, freelance or gig employees may not receive income statements and need to track income received throughout the year and report it on tax returns as earned income.
5. High Home Office Deductions
Claiming an excessive or unwarranted amount, like all monthly rent, can raise red flags. Determine the correct amount of space used for work and the expenses associated with a home office.
Deductions large in proportion to a taxpayer's income can target a return for review. If an accountant earns $50,000 from a home office, deductions totaling $30,000 raise concern.
6. Income Thresholds
Taxpayers earning more than $1,000,000 each year have greater odds of an IRS audit. In 2022, 23 of 1000 returns, or 2.3%, were audited at this income level. However, the odds of being audited in 2022 varied for lower-wage individuals. According to the IRS, the typical taxpayer reports an income of less than $200,000. The odds of these taxpayers facing an audit was just 1.9 out of every 1,000 returns filed.
The IRS may look at returns filed within the last three years. A substantial error may add additional years of review, usually up to six, to the audit.
Who Is Most at Risk for an Audit?
Somesituations tend to attract IRS attention more than others. Individuals who participate in a limited partnership, control a trust or make tax shelter investments will have complicated tax returns that may expand IRS scrutiny. Small business owners who deal mainly with cash transactions are also an easy target for tax return reviews. Other situations may include:
- A tax return linked with another individual under audit.
- The income reported does not match Forms W-2 or Form 1099.
- There are errors on Schedule C as a sole proprietor for reported business income or losses.
- Unusual deductions on a tax return.
Several levels of audits exist, from a correspondence audit via a letter of inquiry to a field audit or in-person audit.
What Information Is Required in an Audit?
The IRS provides specific documents they would like to see, such as bank statements or receipts. Taxpayers should keep all recordsused to prepare their tax return for at least three years from the date the tax return was filed in case of an audit.
How Are Taxpayers Notified of an Audit?
The IRS will always notify taxpayers by mail and will not initiate an audit by telephone.
What Happens After the Audit?
Taxpayers who agree with the audit findings of the IRS will sign the examination report. For the money owed, several payment options are available and explained in IRS Publication 594.
The Bottom Line
The IRS will continue to use audits to increase collections, and the key to avoiding an audit is to be accurate, honest, and modest. Taxpayers should ensure sums tally with any reported income, earned or unearned, and document deductions and donations.
FAQs
Another easily avoidable audit red flag is rounding or estimating dollar amounts on your tax return. Say, for instance, you round $403 of tip income to $400, $847 of student loan interest to $850, and $97 of medical expenses to $100. The IRS is going to see all those nice round numbers and think you're making them up.
What are the red flags for auditing? ›
Another easily avoidable audit red flag is rounding or estimating dollar amounts on your tax return. Say, for instance, you round $403 of tip income to $400, $847 of student loan interest to $850, and $97 of medical expenses to $100. The IRS is going to see all those nice round numbers and think you're making them up.
How do you avoid an audit? ›
You can't always avoid an audit, but thorough records that support your deductions can quickly appease most auditors. Have supporting documentation for any deduction on your tax return, especially those that are significant or subject to special rules, such as rental losses.
What is most likely to trigger an IRS audit? ›
High income
As you'd expect, the higher your income, the more likely you will get attention from the IRS as the IRS typically targets people making $500,000 or more at higher-than-average rates.
What are red flags to the IRS small business? ›
Too many deductions taken are the most common self-employed audit red flags. The IRS will examine whether you are running a legitimate business and making a profit or just making a bit of money from your hobby. Be sure to keep receipts and document all expenses as it can make things a bit ore awkward if you don't.
What is the red flag rule? ›
The Red Flags Rule requires specified firms to create a written Identity Theft Prevention Program (ITPP) designed to identify, detect and respond to “red flags”—patterns, practices or specific activities—that could indicate identity theft.
What is considered a red flag under the Red Flags Rule? ›
The Federal Trade Commission added title 16 of the Code of Federal Regulations (CFR), the Red Flags Rule, under the Fair and Accurate Credit Transactions Act of 2003. Red flags are suspicious patterns or practices, or specific activities that indicate the possibility that identity theft may occur.
Who gets audited the most? ›
The two groups most likely to get audited are those earning more than $10 million and taxpayers who claim the Earned Income Tax Credit, who tend to be low- or middle-income workers.
How can I reduce my chances of getting audited? ›
Avoid careless mistakes—like math errors, leaving questions blank, or not signing your tax return—can trigger an audit. Don't take excessive deductions.
What not to say to an auditor? ›
10 Things Not to Say in an Audit Report
- Don't say, “Management should consider . . .” ...
- Don't use weasel words. ...
- Use intensifiers sparingly. ...
- The problem is rarely universal. ...
- Avoid the blame game. ...
- Don't say “management failed.” ...
- 7. “ ...
- Avoid uunnecessary technical jargon.
Taking higher-than-average deductions, losses or credits
If the deductions, losses, or credits on your return are disproportionately large compared with your income, the IRS may want to take a second look at your return.
How do you tell if IRS is investigating you? ›
Signs You May Be Under Investigation
Your IRS auditor seems to disappear without explanation. You or your bank gets subpoenaed for financial records. You stop getting the typical notices the IRS sends for things like penalties and interest. You get a surprise visit from IRS criminal investigation agents.
What throws red flags to the IRS? ›
Not reporting all of your income is an easy-to-avoid red flag that can lead to an audit. Taking excessive business tax deductions and mixing business and personal expenses can lead to an audit. The IRS mostly audits tax returns of those earning more than $200,000 and corporations with more than $10 million in assets.
How far back does IRS audit go? ›
How far back can the IRS go to audit my return? Generally, the IRS can include returns filed within the last three years in an audit. If we identify a substantial error, we may add additional years. We usually don't go back more than the last six years.
What not to say in an IRS audit? ›
Do not lie or make misleading statements: The IRS may ask questions they already know the answers to in order to see how much they can trust you. It is best to be completely honest, but do not ramble and say anything more than is required.
What happens if you get audited and don't have receipts? ›
Missing receipts during an audit can end up costing you a lot of money, either through CPA fees (to put it all together to prove to the IRS that your expenses were legit), through disallowed deductions that increase your taxable income, through expenses that the IRA agent determines were actually payments to executives ...
What are red flags in financial statement audit? ›
If you notice your debt is starting to rise while your income remains stagnant or decreases, you may be facing a critical red flag in your business financial statements. When your debt-to-equity ratio reaches 1:1 (over 100%), your business is considered to be in a debt crisis.
What is audit flag? ›
Audit flags indicate classes of events to audit. Machine-wide defaults for auditing are specified for all users on each machine by flags in the audit_control file, which is described in The audit_control File.
How do I know if Im being audited? ›
The IRS performs audits by mail or in person. The notice you receive will have specific information about why your return is being examined, what documents if any they need from you, and how you should proceed. Once the IRS completes the examination, it may accept your return as filed or propose changes.
What is a red audit? ›
A Red Team audit is meant to simulate a real attack in order to test the global security level of the information system and the awareness of the employees. The objective is to demonstrate the potential consequences of an attack, and to test the reactivity of the defense teams.
