Criminal Defense Lawyers

The Most Common Triggers and Red Flags for IRS Audits and Investigations

Dealing with the IRS can be intimidating. An audit or investigation means digging through your financial records, providing documentation, and essentially proving your innocence when it comes to your taxes. While the odds of being audited remain low, it’s important to be aware of the red flags that may increase your chances of extra IRS scrutiny. This article will break down the most common triggers that could lead to an audit or investigation, and provide tips on how to avoid issues.

Failing to Report All Income

One of the biggest red flags for an audit is when your reported income doesn’t match up with the tax documents the IRS receives from third parties like employers and banks. Even if you simply forgot to include some earnings, underreporting income sends up a red flag and indicates you may be hiding or misrepresenting your finances.

Some common income reporting mistakes include:

• Forgetting to include all your W-2s or 1099 forms from side jobs and freelance work
• Not reporting income from investments, rental properties, prizes/awards, etc.
• Only reporting business income and expenses on Schedule C, but failing to include payments received for services through apps like Venmo or PayPal

To avoid issues, be thorough in tracking all your income sources. Double check tax documents, and report any amounts over $600 received through third party payment apps. Going the extra mile shows good faith and reduces the chance of an audit.

Taking Questionable Deductions or Credits

Another area the IRS pays close attention to is deductions and credits. While write-offs lower your tax bill, improper or excessive claims will raise eyebrows. Targeted deductions include:

• Home office deductions – Strict rules apply here, like using the space exclusively for your business. Make sure to follow IRS guidelines.
• Business travel/meal deductions – These should be actual business expenses, not personal costs. Keep detailed records and receipts.
• Charitable donations – Larger amounts or non-cash donations tend to get reviewed. Get appraisals for donations over $5,000 and document all cash amounts.
• Hobby loss – Reporting business losses year after year will lead to scrutiny of whether your activity is actually a business or just a hobby.
• Earned Income Tax Credit – Due to high improper payment rates, this credit is closely monitored. Confirm you qualify based on income thresholds.

Document everything and only make claims supported by the tax code. Keep records like receipts, logs, appraisals and other evidence. Consult a tax pro if you’re unsure.

Being Self-Employed

Self-employed taxpayers have high audit rates since there is more room for errors, omissions and questionable deductions. Areas the IRS focuses on include:

• Unreported income – Ensure you document all cash/payments received. Deposit income into your business bank account.
• Excess expenses – Watch that travel, meal, vehicle use and other expenses are reasonable and business-related. Expect scrutiny if expenses exceed industry norms.
• Business use of home – Review home office deduction rules and track use carefully. If audited, you may need to prove exclusive business use.
• Business structure – Classifying your business as an S corporation when it doesn’t meet IRS criteria could trigger an audit. Consult a tax pro on appropriate business structure.
• Losses – Reporting losses several years in a row raises red flags about whether your activity is truly a business or just a hobby.

Keep immaculate records, follow all IRS rules, and work with a tax professional if you have a complex return. Being organized and compliant goes a long way toward avoiding audit triggers.

Unreported Foreign Income or Accounts

The IRS has become increasingly strict about tracking foreign assets and income. Some key reporting requirements include:

• FBAR – You must file a Report of Foreign Bank and Financial Accounts (FBAR) if you had over $10,000 in total foreign accounts at any point in the year.
• Form 8938 – If foreign assets exceed threshold amounts, you must report them on Form 8938. For single taxpayers, the threshold is $50,000.
• Foreign income – Any foreign employment income or investment income needs to be reported.
• Business activities – Foreign business operations and partnerships must be disclosed.
• Gifts/inheritances – Foreign gifts over $100,000 and foreign inheritances over $60,000 require reporting.

Failure to disclose foreign income or assets can lead to severe penalties. The IRS has also cracked down on hiding assets in offshore accounts. Be transparent about all foreign holdings and income sources.

Large, Suspicious Charitable Donations

While most taxpayers give to charity out of generosity, some bad actors use donations to lower tax bills or impress others. IRS computers flag returns when deductions seem questionable, including:

• Donating unusually high percentages of income
• Donating noncash assets valued at $5,000+ without an appraisal
• Having several years of large charitable deductions
• Having donations that conveniently lower taxable income under certain thresholds

If you give generously, be sure to follow all appraisal and documentation requirements. Spread large donations over several years. And make sure amounts match your income level and giving history.

Math Errors

Even simple math mistakes can get your return flagged for review. Common errors include:

• Transposed numbers
• Calculation errors
• Mismatching amounts on supporting forms
• Incorrect Social Security numbers

Before filing, double check your return for accuracy. Make sure all names, numbers, and amounts match perfectly across forms. Consider using tax software or a preparer to minimize computational errors.

Previous Audits or Issues

The IRS keeps track of your audit history. If you’ve been audited before, expect increased scrutiny in subsequent years. Returns may get flagged if you:

• Previously filed late returns or failed to file
• Have existing tax liens or levies
• Were recently audited
• Frequently amend returns after filing

If you’ve had tax issues in the past, be extra diligent going forward. Ensure filings are timely and accurate. Be prepared to back up figures with documentation. And consider consulting a tax pro to avoid repeat mistakes.

How to Avoid IRS Issues

While audits can feel random, taking proactive steps can minimize your risks. Some best practices include:

• Report all income – Track and disclose all earnings, no matter how small. Match amounts on your return to 1099s and W-2s.
• Document deductions – Keep detailed records, mileage logs, receipts and other proof to validate write-offs.
• Check for errors – Review returns carefully before filing. Fix any typos, transposed numbers or mismatched amounts.
• Disclose foreign assets – File all required forms like FBAR and 8938 to report foreign holdings.
• Review unusual items – Don’t push the envelope with questionable deductions or credits that seem too good to be true.
• Work with a pro – If your return is complex, get help from a trusted CPA or enrolled agent.
• Ask questions – If you’re not sure about something, consult the IRS website or chat with an expert before filing.

No system is foolproof, and anyone can be audited. But following the rules, reporting accurately, and keeping detailed records will help you stay off the IRS radar. Being organized and careful offers the best protection if you do get that dreaded audit notice.

Dealing with an Audit or Investigation

If you do receive notice that you’re being audited or investigated, don’t panic. Here are some tips for getting through the process:

• Don’t ignore it – Respond promptly to all notices and requests. Missing deadlines can lead to immediate fines.
• Get representation – Consider hiring a tax pro to handle the audit process for you. An experienced CPA or enrolled agent can be a huge asset.
• Gather documentation – Locate receipts, canceled checks, logs, appraisals and anything else that supports the return figures.
• Be cooperative – Answer questions fully and provide requested documents in a timely manner. Don’t be combative.
• Think before signing – Don’t sign any agreements you don’t understand or feel are inaccurate without consulting your representative.
• Negotiate if needed – If the IRS finds errors, your representative can negotiate on your behalf to minimize fines and penalties.
• Learn for next time – If violations are found, determine the root cause and adjust processes going forward.

The IRS just wants to collect taxes owed. With the right help and documentation, you can often resolve audits with minimal disruption or costs. Being organized and working collaboratively can help move the process along.

When to Hire Tax Help

With the tax code so complex, getting expert assistance can be a smart move. Consider involving a tax pro if:

• You have a complicated return with rental properties, investments, businesses, etc.
• You’re going through a major life event like marriage, divorce, retirement, etc.
• You’ve been audited in the past.
• You lack time or confidence to handle taxes yourself.
• You want to minimize audit risk.
• You need help responding to IRS notices.
• You have unreported foreign income or assets.
• You have previous tax issues or errors to correct.

Reputable CPAs, enrolled agents, and tax attorneys have the experience to ensure compliance, maximize deductions legally, and stand by you in an audit. They also stay up-to-date as tax laws change. Their expertise can provide valuable peace of mind.

The Bottom Line

While the IRS has limited resources, they do look for certain red flags that increase audit risk. However, there’s no reason to fear the process if you report accurately, follow the rules, and keep proper documentation. Work with a tax pro if you have concerns or complexities. And if audited, stay calm, cooperate fully, and rely on your representative. Being organized and transparent goes a long way toward a smooth process and outcome. With the right preparation, an IRS inquiry doesn’t have to be the nightmare that many fear.