- An IRS audit can be triggered in several ways, and even taxpayers who believe they’ve correctly filled out and submitted their tax return may find themselves facing an audit.
- In addition to incorrectly reporting income, some of the most common audit triggers include taking too many business deductions, operating a cash-only business, and not reporting money in foreign bank accounts.
- When an audit is triggered, hiring a tax attorney is the best way to deal with the lengthy and potentially expensive process.
No taxpayer wants to have to deal with an audit, but unfortunately, they do occur. Because facing an audit can be very time-consuming and stressful, it’s important to avoid this situation in whatever way you can. Many people don’t realize that there are several circ*mstances that can trigger an audit by the IRS, and understanding these situations will help you limit your chances of receiving an audit notice. Here are a few of the most common IRS audit triggers that you should be aware of to avoid frustration.
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2Failing to Report Income
3Money in Foreign Bank Accounts
4Taking Too Many Business Deductions
5Earning Beyond a Certain Threshold
7Dipping Into Retirement Funds
8Self-Employment and Hobbies As Businesses
9Don’t Throw Away Your Returns Too Early
The IRS Computer System
The IRS receives millions of tax returns every year and to manage these returns, the agency uses something known as the Discriminant Inventory Function System (DIF). This system scans every tax return received by the IRS, and if it detects something unusual with the return, it will flag it for further inspection by an IRS agent. A return being flagged by the DIF system is typically the first step in an audit.
If you want to avoid an audit, you need to make sure that your return is correctly prepared so that it won’t be flagged by the DIF system. When the system scans your return, it searches for a variety of issues. Being aware of these issues can potentially help you avoid an audit.
For instance, when filling out your return, you must be certain that the income you are reporting matches the income listed on your 1099 or W2. The IRS receives copies of these documents, so the agency will know exactly how much you have earned.
The DIF system also scans the Social Security numbers listed on a return. If two different taxpayers try to claim the same dependent, the system will detect that the dependent’s social security number is listed on two returns and will then flag those returns.
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To avoid having your return flagged, potentially resulting in an audit, you should double-check everything on your return before submitting it to the IRS. Make sure that all the information is correct, and that you have included all necessary documents. You may want to use some form of tax preparation software or hire a tax professional to make sure you’ve completed your return correctly.
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Failing to Report Income
AnIRS auditcan be triggered in a variety of ways, but the most common reason you may face an audit is the failure to report all of your income. Fortunately, this is also the easiest audit trigger to avoid.
Most people that fail to report all their income aren’t doing so intentionally. For instance, if you work for multiple institutions and have multiple sources of income, you simply may have lost track of some of the money that you earned. Some sources of income that are easy to forget to report include:
- Form 1099 income, which you would earn from contract work.
- Money in a brokerage account that you forgot you owned.
- College savings account distributions.
Every tax form that you are sent will also be received by the IRS, and this includes distributed income. The IRS will compare the income listed on these forms to what you reported on your tax return. If they don’t match, an audit will be initiated.
Money in Foreign Bank Accounts
Having foreign bank accounts can also result in an IRS audit. Under theForeign Account Tax Compliance Act, there are very strict rules for reporting money stored in foreign accounts. First, the foreign banks must inform the IRS of any account holders who are also United States citizens. Second, taxpayers who own foreign assets worth $50,000 or more must report these assets on IRS Form 8938.
Previously, reporting foreign assets only required checking a box on your tax return. Now, there are three different steps to report foreign assets:
- Check the box.
- Identify the bank at which your foreign account is held.
- State the highest amount held in the foreign account during the previous year.
Transparency is the point of these new regulations. Unfortunately, these regulations also mean that taxpayers with foreign bank accounts are also much more at risk for an audit, both because it can be easy to make a mistake with these reporting requirements and because possession of a foreign bank account is often perceived as an attempt to hide money from the IRS.
Taking Too Many Business Deductions
Lowering their tax burden is a goal of most business owners. If you own a business, you will likely want totake advantage of as many available tax deductions as possible. While this is understandable, it also means that you’ll be increasing your chances of facing an audit.
If you take a large amount in business tax deductions, the IRS will examine your taxes very carefully. Imagine, for example, that you frequently need to travel for your business. The IRS keeps a list of different professions and their typical travel amounts. If you deduct 20 percent more travel time than is standard for your profession, then an audit and back taxesare likely.
Incorrectly deducting a business vehicle is another reason you might have to deal with an audit. For instance, if you take a vehicle home, it generally won’t be considered a business vehicle, even if you do use it for work. You should always list a business purpose when deducting a vehicle.
Failing to separate personal and business expenses may also result in an audit. Deducting business meals can often be tricky, particularly if you are deducting more than the norm for your profession. Take too many deductions for business meals, and an audit may very well be in your future.
Earning Beyond a Certain Threshold
The amount that you earn can also contribute to your likelihood of being audited. Typically, 1 percent of IRS audits are for taxpayers reporting less than $200,000 in earnings. If you earn above this threshold, your chances of being audited will increase. The more you earn, the more likely an audit becomes.
The reason that higher-earning individuals and businesses are more at risk for an audit is that their tax returns are more complicated than those who earn less. The IRS also wants to maximize the taxes that they collect, and auditing higher earners usually results in more taxes collected than auditing people and businesses that earn less money.
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Dealing in Cash
In an increasingly digital world, cash transactions are becoming a thing of the past, which is why the IRS views large cash transactions as suspicious. Businesses must report large transactions to the IRS. Typically, these transactions are $10,000 or more. If you spend this much money in cash as an individual, you can expect an audit notice in your mailbox.
The reason that large cash transactions can result in an audit is that it can be difficult to determine the origin of this money. Imagine that you’ve been saving for a used car and take $10,000 out of your bank account to pay for the car. Then, you take this money to a dealership to purchase your car. Because of the previously mentioned reporting requirement, the dealership will notify the IRS of the transaction, and due to the amount, the agency will probably contact you for more information. In particular, they may request documentation of where and how the money was earned.
Operating a cash-only business is another common audit trigger. The IRS’s assumption is that cash-based businesses can more easily hide income since they may not document most transactions. The biggest red flag is if the deductions on your tax return reflect a lifestyle that doesn’t match the income you are reporting for your business.
Dipping Into Retirement Funds
When you’re facing a tough financial situation, it’s common to look for any solution for getting your finances back in order. For example, if you’re suddenly facing a large amount of back taxes, it may be tempting to dip into your retirement fund to get yourself out of due back taxes. If you decide to take money out of your retirement fund early, you may face an audit in your future.
Taking money out of an IRA or 401(k) before you are actually retired is another common audit trigger. The reason that this can result in an audit is that people who dip into their retirement fund typically make mistakes on their tax return related to this money. Auditing for this issue is more about the IRS making sure that it gets the money that it’s owed than it is about preventing fraud.
The mistake that many taxpayers make when dipping into their retirement fund is failing to pay the early withdrawal penalty. If you take retirement money early and are 59.5 years old or younger, you must pay a 10 percent penalty. If you’re older than this and take a withdrawal, you won’t need to pay a penalty, but income taxes will usually apply to the money you withdrew. There are certain situations where the early withdrawal penalty will not apply:
- You become permanently disabled.
- You take money out of your IRA to pay for non-reimbursed medical expenses.
- You are a first-time homebuyer and have withdrawn $10,000 or less from your retirement to pay for your home.
- You have passed away before the age of 59.5. The penalty will not apply to your beneficiaries or estate.
Self-Employment and Hobbies As Businesses
While every taxpayer can find themselves facing an audit, IRS audits are much more common for those who work as freelancers or sole proprietors. The reason for this is that freelance workers and sole proprietors have access to a variety of deductions, and as we’ve discussed, the more deductions that you take, the likelier an audit. Sole proprietors and freelancers can take deductions for the following issues, among others:
- Home office expenses.
- Mileage expenses.
- Business meals, lodging, and entertainment.
These deductions must be reported on a Schedule C form. To determine the amount of taxable income, the deductions are subtracted from the freelancer’s or sole proprietors’ total revenue. As with traditional business deductions, sole proprietors and freelancers claiming deductions outside the norm for their profession will likely be audited. For example, if a typical freelancer in your industry claims a 20 percent deduction for travel expenses, and you claim 40 percent, you may end up having to deal with an audit.
Another reason that the IRS may audit your tax return is that you try to claim that your hobby is actually a business and then try to take advantage of business deductions. The IRS has a variety of rules that it uses to distinguish hobbies from businesses and failing to understand these rules can result in an audit. For your hobby to reach the level of a business, you must have earned a net profit in three tax years out of the last five.
Don’t Throw Away Your Returns Too Early
As you can see, there are countless reasons that you may find yourself dealing with an audit, which means you need to make sure you’re prepared for this common tax issue. In particular, you need to be sure that you aren’t throwing away your tax returns and related documents too early.
When the IRS initiates an audit, it will request a wide variety of documents, including copies of your old tax returns. If you no longer have these returns, it can make the audit process much more difficult, and it may increase the chances of an unfavorable result.
Generally, you should keep a tax return until the audit statute of limitations has expired, which for federal tax returns is three years after the return was filed. Your state taxing authority may have a longer statute of limitations, so you should check the rules in your state before throwing away your state returns. In addition to copies of your tax returns, other documents that you should save include:
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- Copies of 1099 and W-2 Forms.
- Charitable donation acknowledgment letters.
- Tax-deductible expense receipts.
The biggest fear of most people facing an IRS audit is that they’ll eventually need to pay back taxes. Fortunately, with the help of Solvable, you can deal with your back taxes quickly and easily. We’ve connected thousands of people with the best back tax assistance companies in the country, and we are here to do the same for you. To get started, read our back tax assistance company reviews or contact us with your questions.
FAQs
An IRS audit can be triggered in a variety of ways, but the most common reason you may face an audit is the failure to report all of your income. Fortunately, this is also the easiest audit trigger to avoid. Most people that fail to report all their income aren't doing so intentionally.
What usually triggers an IRS audit? ›
Failing to report all your income is one of the easiest ways to increase your odds of getting audited. The IRS receives a copy of the tax forms you receive, including Forms 1099, W-2, K-1, and others and compares those amounts with the amounts you include on your tax return.
What triggers most audits? ›
Top 10 IRS Audit Triggers
- File a return with math errors. ...
- File a schedule C. ...
- Take the home office deduction. ...
- Lose money consistently. ...
- Don't file or file incomplete returns. ...
- Have a big change in income or expenses. ...
- Mix business and personal expenses. ...
- Use your car for business.
Correspondence audits are the most common IRS audit types. The Internal Revenue Service conducts this audit to request additional documentation from taxpayers.
What flags you for an IRS audit? ›
Some red flags for an audit are round numbers, missing income, excessive deductions or credits, unreported income and refundable tax credits. The best defense is proper documentation and receipts, tax experts say.
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 is an IRS audit looking for? ›
An IRS audit is a review/examination of an organization's or individual's accounts and financial information to ensure information is reported correctly according to the tax laws and to verify the reported amount of tax is correct.
What is the odd of getting audited? ›
The vast majority of more than approximately 150 million taxpayers who file yearly don't have to face it. Less than one percent of taxpayers get one sort of audit or another. Your overall odds of being audited are roughly 0.3% or 3 in 1,000. And what you can do to even reduce your audit chances is very simple.
What's the worst that can come from an audit? ›
Tax evasion and fraud penalties are some of the worst IRS audit penalties that you can face. The civil fraud penalty is 75% of the understated tax. For instance, if your tax return showed that you owed $10,000 less than you do, you will owe the $10,000 in tax plus a 75% penalty of $7,500.
Is the IRS going to audit everyone? ›
Does the IRS audit everyone? It may be a relief to know that the IRS does not have the resources to audit everyone's return. It sets priorities based on certain factors reported in the return and the person who filed it. This is how they try to find potential tax revenue not reported.
What is the chance of being audited by the IRS? The overall audit rate is extremely low, less than 1% of all tax returns get examined within a year. However, these nine items are more likely to increase your risk of being examined.
What happens if you get audited and don't have receipts? ›
You may have to reconstruct your records or just simply provide a valid explanation of a deduction instead of the original receipts to support the expense. If the IRS disagrees, you can appeal the decision.
Where do most IRS audits occur? ›
The most audited county in the U.S. is Humphreys County, Mississippi, where median household annual income is $24,000. Higher audit rates in poor counties stem from the IRS targeting taxpayers who claim the Earned Income Tax Credit. Nine of the 10 most audited counties in the U.S. are in Mississippi.
How do I survive an IRS audit? ›
How to Survive an IRS Audit
- Don't ignore the notice. You generally have 30 days to respond to an audit notice. ...
- Read and follow the notice. ...
- Organize your records. ...
- Replace missing records. ...
- Bring only what you're asked for. ...
- Don't be a jerk! ...
- Provide only copies. ...
- Stay on point.
The Short Answer: Yes. Share: The IRS probably already knows about many of your financial accounts, and the IRS can get information on how much is there. But, in reality, the IRS rarely digs deeper into your bank and financial accounts unless you're being audited or the IRS is collecting back taxes from you.
What are 9 red flags that could lead to a tax audit? ›
Red flags: Failing to report all taxable income; taking low wages; overstating deductions; claiming high losses well above those in earlier years; not recording debt forgiveness; intermingling personal and business income and expenses; excessive travel and entertainment expenses; and amended returns.
How worried should I be about an IRS audit? ›
Don't worry about dealing with the IRS in person
Most of the time, when the IRS starts a mail audit, the IRS will ask you to explain or verify something simple on your return, such as: Income you didn't report that the IRS knows about (like leaving off Form 1099 income) Filing status. Dependents.
How serious is an IRS audit? ›
It will impose tax penalties if errors are found in your tax returns. There's also the possibility of jail time in serious cases of tax evasion and tax fraud. The IRS may normally flag one return for audit but it does have the authority to audit returns from the past several years.
Is an IRS audit a big deal? ›
A tax audit doesn't automatically mean you're in trouble. While it's true that the IRS can audit people when they suspect they have done something wrong, that's often not the case. The IRS audits a portion of the taxpaying public every year. You can be selected purely as a matter of chance.
How far back can IRS audit an individual? ›
In most situations, the IRS can go back three years. That means if your 2016 tax return was due April 2017, the IRS has three years from April 2017 to audit you (if you file the return timely, either before or on the April due date).
The primary consequence of being audited and found guilty is that you will receive penalties. Depending on your situation, the IRS penalties could include paying back taxes owed plus interest and additional tax audit penalties.
Do you need original receipts for an IRS audit? ›
The IRS will only require that you provide evidence that you claimed valid business expense deductions during the audit process. Therefore, if you have lost your receipts, you only be required to recreate a history of your business expenses at that time.
How much money until you get audited? ›
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.
Is it expensive to get audited? ›
If charged as a flat fee, your total tax audit representation cost could be anywhere between $2,500 and $10,000 per tax year under examination. It may go even higher if your case goes to the U.S. Tax Court.
Who gets audited more often? ›
The IRS on Monday said an internal investigation has found that Black taxpayers are audited at higher rates than would be expected given their share of the U.S. population.
Can you go to jail for IRS audit? ›
If your tax return is being audited by the IRS, there is a greater likelihood that the IRS finds errors in your return, which can result in hefty IRS audit penalties and interest. In more extreme cases, the penalties can cost you tens of thousands of dollars – or even result in jail time.
Does the IRS catch every mistake? ›
The average individual's chances of being audited are pretty slim: Of the roughly 165 million returns the IRS received last year, approximately 626,204, or less than 0.4%, were audited. A review of a federal tax return can be triggered at random, but certain behaviors are more likely to be flagged than others.
Do poor people ever get audited? ›
For every 1,000 low-income wage earner tax returns, in which the filers qualified for the anti-poverty ETIC, 7.9 were audited. In 2021, the odds of millionaires being audited were 2.6 of each 1,000 returns. For low-income wage earners, it was 13.0 out of a 1,000.
How many times can you be audited by the IRS? ›
Our own tax experts at The Tax Institute state, “The IRS can conduct only one inspection of a taxpayer's books and records for any given year unless the taxpayer requests a second inspection or the IRS notifies the taxpayer in writing that an additional inspection is necessary.”
Is the IRS more likely to audit poor people? ›
The burden of the IRS audits disproportionately falls on lower-income families, with households making less than $25,000 facing the largest audit scrutiny among other income ranges in 2022, according to data released by TRAC.
The IRS receives information from third parties, such as employers and financial institutions. Using an automated system, the Automated Underreporter (AUR) function compares the information reported by third parties to the information reported on your return to identify potential discrepancies.
How long does an IRS audit usually take? ›
How long does an IRS audit take to complete? Now for the answer to the all too familiar question every tax attorney gets: “How long does a tax audit take?” The IRS audit period itself should generally take no more than five to six months. Sometimes with proper preparation, they can be resolved faster.
Does amending taxes trigger audit? ›
Filing an amended return does not trigger an audit. The IRS website specifically notes that all returns, including amended returns, go through a screening process that identifies tax returns for further review by an auditor.
How much income can go unreported? ›
Depending on your age, filing status, and dependents, for the 2022 tax year, the gross income threshold for filing taxes is between $12,550 and $28,500. If you have self-employment income, you're required to report your income and file taxes if you make $400 or more.
What is the Cohan rule? ›
Cohan rule is a that has roots in the common law. Under the Cohan rule taxpayers, when unable to produce records of actual expenditures, may rely on reasonable estimates provided there is some factual basis for it. The rule allows taxpayers to claim certain tax deductions on the basis of such estimates.
Can you check IRS audit online? ›
Taxpayers who want to check their account information including balance, payments, tax records and more, can log into their IRS online account. It's a simple and secure way to get information fast.
How much money does IRS investigate? ›
In Fiscal Year (FY) 2022, the IRS collected more than $98.4 billion in unpaid assessments on returns filed with additional tax due, netting about $58.8 billion after credit transfers (Table 25XLSX).
What time of year does the IRS send out audit letters? ›
Filers most commonly receive letters from the IRS notifying them of the examination in the fall or winter months of the previous tax filing year. Yet, the auditors can mail the notifications throughout the year.
Does the IRS monitor Zelle? ›
Here is a list of our partners and here's how we make money. If you're a user of online payment apps such as Venmo, you might have heard about new measures the IRS is taking to track income delivered though these services. But there's one widely used app that says its tax-reporting policies won't change: Zelle.
How do I know if my bank account is being monitored? ›
5 Ways You Can Tell If Your Bank Account Has Been Hacked
- Small unexplained payments.
- Unexpected notifications from your bank.
- A call claiming to be your bank demands information.
- Large transactions empty your bank account.
- You learn your account has been closed.
According to TRAC IRS, the overall audit rate for all taxpayers in 2022 (for the 2021 tax year) was 0.38%. Taxpayers that used a Schedule C to report income (most self-employed individuals) have a higher rate—between . 08% and 1.6%, according to 2019 figures.
What commonly triggers an audit? ›
What triggers an IRS audit? A lot of audit notices the IRS sends are automatically triggered if, for instance, your W-2 income tax form indicates you earned more than what you reported on your return, said Erin Collins, National Taxpayer Advocate at the Taxpayer Advocate Service division of the IRS.
How does the IRS choose who to audit? ›
Selection for an audit does not always suggest there's a problem. The IRS uses several different methods: Random selection and computer screening - sometimes returns are selected based solely on a statistical formula. We compare your tax return against "norms" for similar returns.
What income is most likely to be audited? ›
Who gets audited by the IRS the most? In terms of income levels, the IRS in recent years has audited taxpayers with incomes below $25,000 and above $500,000 at higher-than-average rates, according to government data.
How likely is the IRS to audit you? ›
What is the chance of being audited by the IRS? The overall audit rate is extremely low, less than 1% of all tax returns get examined within a year.
How will I know if the IRS will audit me? ›
If the IRS decides to audit, or “examine” a taxpayer's return, that taxpayer will receive written notification from the IRS. The IRS sends written notification to the taxpayer's or business's last known address of record. Alternatively, IRS correspondence may be sent to the taxpayer's tax preparer.
What happens if you are audited and don't have receipts? ›
You may have to reconstruct your records or just simply provide a valid explanation of a deduction instead of the original receipts to support the expense. If the IRS disagrees, you can appeal the decision.
Does the IRS audit people with low income? ›
The burden of the IRS audits disproportionately falls on lower-income families, with households making less than $25,000 facing the largest audit scrutiny among other income ranges in 2022, according to data released by TRAC.
How long does it take for the IRS to decide to audit you? ›
Most audits start a few months after you file your return
Once you answer the IRS' questions about the accuracy of your return, the IRS will release your refund. Audits that start soon after filing usually focus on tax credits, such as the earned income tax credit and the child tax credit.
Is it bad if the IRS audits you? ›
It will impose tax penalties if errors are found in your tax returns. There's also the possibility of jail time in serious cases of tax evasion and tax fraud. The IRS may normally flag one return for audit but it does have the authority to audit returns from the past several years.
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