Red Flags That May Trigger an IRS Audit
By Jane Young, CFP, EA
The fear of being audited by the IRS is a real concern for many taxpayers. However, if you accurately report your income and deductions and maintain good records you should be fine. A report by Syracuse University’s Transactional Records Clearinghouse found that in fiscal year 2022, the IRS audited 626,204 returns. This was down from 659,003 in fiscal year 2021. About 85% of the audits were correspondence audits where a letter with the perceived discrepancy was mailed to the taxpayer for resolution.
The odds of being audited have fallen to 3.8 out of 1,000 in 2022 down from 4.1 out of 1,000 in 2021. However, the IRS is working to increase the audit rate for the wealthiest Americans. According to the US Government Accountability Office (GAO) report published in 2022, taxpayers who earn below $25,000 and over $500,000 will be audited at an above average rate. Returns claiming the Earned Income Tax Credit have had a high rate of overpayment resulting in the need for a higher level of audits.
Although the odds of an audit are low, several things may trigger an audit. The most common is the failure to report all your income. The IRS receives duplicate copies of your W2’s, 1099s, and K1 reports. If you forget to report income that is reported on a document filed with the IRS, you will receive a letter from the IRS.
Reporting deductions or credits that are unusual for your income level will also get the attention of the IRS. The IRS has a Discriminant Information Function (DIF) or a computer program that looks for anomalies and duplicate information. It compares returns to those of others with similar income for deductions that are unusual. They are also looking for inconsistencies such as exceptionally large charitable contributions by someone with a relatively low income. This should not discourage you from taking legitimate deductions but be sure to maintain good records.
If self-employed, the IRS is watching for excessive deductions for travel, vehicles, mileage, meals, casualty losses and bad debt expense. The IRS will compare your business to others with similar occupational codes and income to uncover excessive deductions. A home office deduction also gets added scrutiny by the IRS. Do not be afraid to claim it if you meet the qualifications and have a separate area used exclusively for your business.
The IRS is watching for hobby losses being treated as a business. Generally, you need to report a profit in three of the last five years and demonstrate the intention to make a profit and operate a real business. Cash based businesses, large cash deposits and a large amount of foreign assets may also attract IRS attention.
An audit does not mean the IRS assumes you are guilty of criminal behavior. It is usually caused by missing information or an unintentional error. Most audits are by mail requesting clarification, documentation, or a minor adjustment to income reported.