According to a 2023 report published by the Congressional Research Service, less than 1% of Americans are subjected to an audit by the Internal Revenue Service (IRS) each year. In fact, if you earn less than $1 million, the chance you’ll be audited is less than 5 out of 1000.
How can you ensure you’re not one of the “lucky” ones? Avoid these red flags.
Top 5 Red Flags
Unreported Income
The IRS receives copies of W-2s, 1099s, and other forms that report individual income to taxpayers. If you fail to report income—even small amounts from tips, freelance work, or even unemployment benefits—the discrepancy between your records and theirs can trigger an audit.
Calculation Errors
Simple arithmetic mistakes, miscalculations, and recording errors can cause the IRS’s automated systems to flag your return for human review. Even minor errors may delay refunds or prompt follow‑up questions, putting you on a “watch” list when filing future tax returns.
Excessive Business Expenses
The IRS flags business expenses as excessive when they deviate from industry norms, are inconsistent with the nature and size of the business, or appear to be personal. Warning signs include deductions in the expense categories most prone to abuse, such as the home office deduction. For example, if the taxpayer cannot support the claim that home office space was used exclusively for business purposes, it might trigger an audit, especially if that person is an employee rather than a business owner.
- Claiming Credits or Deductions You Don’t Qualify For
Taking refundable credits, such as the Earned Income Tax Credit (EITC), or deductions for a home office when you don’t meet strict criteria can prompt the IRS to scrutinize your return. In fact, the Earned Income Tax Credit is so often abused that you are almost twice as likely as the average taxpayer to be audited if you claim the EITC.
Large Cash Transactions
Businesses that handle a significant volume of cash, including restaurants, salons, or taxi services, are more likely to be audited because cash is harder to track and may be underreported. Similarly, single substantial cash transactions—both deposits and withdrawals—can indicate that funds are being diverted to avoid taxation.
Additional Red Flags
While not all triggers are avoidable, it is important that you file your tax return as accurately as possible to prevent paying penalties and interest on the back taxes you owe in the event you are audited. Here are five more red flags that alert the IRS’s automated review system to scrutinize your tax return.
Repeated Business Losses
Reporting business losses year after year on a Schedule C may lead the IRS to question whether your activity is a legitimate business or merely a hobby. If the IRS determines that your small business is actually a hobby, deductions will be disallowed, and you could be responsible for unpaid taxes, penalties, and interest.
Rounded or “Neat” Numbers
If your figures are too “neat”—for example, if many amounts are rounded to the nearest hundred or thousand—this can indicate estimated rather than precise record‑keeping, attracting the IRS’s attention. Round only to the nearest dollar amount when reporting numbers from your tax documentation.
- Amended Returns with Significant Changes
Filing an amended return, a corrected version of a previously filed tax return, can attract extra attention, especially if it significantly reduces your tax liability. The IRS reviews amended returns to determine whether changes were warranted and properly documented.
- Receiving or Selling Cryptocurrency
Barclays, an international financial institution headquartered in London, estimates that Americans who trade cryptocurrency fail to pay approximately $50 billion a year in owed taxes. The IRS added a question to Form 1040 in 2022 that asks taxpayers if they had “[received, sold, exchanged, or otherwise disposed of] any financial interest in any virtual currency” during the preceding tax year.
High Income
Taxpayers earning substantially high incomes, more than $1 million a year, tend to receive more scrutiny by the IRS than those who earn less, especially if they have foreign bank accounts, deduct excessive business expenses or real estate losses, pay themselves an unreasonably low salary, or make charitable donations that are larger than their same-income peers.
The number of audits conducted during any given tax year is a direct result of the resources—personnel and time—allocated to the IRS for that purpose. The percentage of IRS audits has significantly decreased in the last ten years due to drastic budget cuts. For that reason, the IRS has shifted its focus away from lower-income earners and small businesses.
Key Takeaways
Only a small percentage of American taxpayers is ever audited. Being audited is always a hassle. But if you’ve retained appropriate records for documentation purposes and reported income, credits, and deductions accurately on your tax return, an audit will only be a minor inconvenience.
If you are concerned that the red flags on your tax return might trigger an IRS audit, seek the services of a professional tax preparer. At AMG Finance, our experienced staff ensures that your tax return is filed accurately, minimizing the risk of being audited. Contact us to schedule an appointment.
