No one wants to hear from the Internal Revenue Service (IRS) asking questions about their tax return. Getting audited can be stressful, time-consuming, and potentially costly if you owe more taxes, penalties, or interest.
According to the 2023 Congressional Research Service (CRS) report, less than 1% of individual income tax returns are selected for audit each year. While this percentage seems small, there are audit-triggering actions or situations I’ve learned to avoid or double-check as a former employee, self-employed taxpayer, and business owner.
1. Large Income Discrepancies
If your income tax returns have large income discrepancies, the IRS might flag you for potential tax underpayment or unreported income.
Remember that the IRS has your income returns from previous years. They can also access income reported through documents such as Form W-2 (Wage statements your employer sends to the IRS) or Form 1009-S (proceeds from a real estate sale).
Be proactive and document reasons for income discrepancies—validated with proof—to help avoid issues.
2. Claiming Excessive Business Expenses for Multiple Years
Claiming excessive business expenses can artificially reduce taxable income, which results in lower tax liabilities than legally owed. Expense examples include vehicles, equipment, office supplies, travel, and meals.
When individuals or businesses consistently report high expenses disproportionate to their income over several years, it raises suspicion of potential tax through inflated deductions. The IRS must verify if these consistently high business costs are legitimate and business-related.
As Kyle Getzen, CPA and Tax Manager at Osborn Morano CPAs, tells us:
“Reporting losses, especially from activities that could be considered hobbies (like photography or dog breeding), or reporting multiple years of losses for what the IRS might consider a hobby rather than a legitimate business.”
3. Significant Charitable Donations
While charitable deductions directly lower taxable income, the IRS will often verify large donations to ensure they are genuine and meet the requirements for deduction. To prevent red flags, ask charities for written acknowledgments of your donations amounting to $250 or above.
4. Failure To Report All Income
Reporting incomplete or inaccurate income numbers is one of the fastest ways to trigger IRS scrutiny and audits. Drastic drops in reported income and unreasonably low self-employed earnings are common discrepancies that raise suspicion of potential tax evasion.
The IRS regularly matches information returns (1099 forms) submitted by employers and other businesses to personal tax returns. Discovery of mismatched income would stand out and trigger an audit. Document all your income, cash transactions, investment accounts, gig work, side jobs, and other earnings to avoid issues.
5. Claiming the Earned Income Tax Credit (Eitc)
The Earned Income Tax Credit (EITC) is a refundable tax credit designed to assist low-to-moderate-income individuals and families. The EITC has one of the highest improper payment rates due to the complexity of rules. Eligibility changes with changes to your income, marital status, and number of qualified children.
Prior issues, such as a history of denied EITC claims, also trigger follow-up audits. The IRS scrutinizes EITC claims to ensure eligibility criteria are met. This way, those who need EITC can claim accurately calculated amounts. IRS audits also help the government reduce billions lost annually to improper EITC payments.
6. Large Cryptocurrency Transactions
Cryptocurrency is a relatively new asset class. The IRS is still updating laws and regulations of virtual currencies, and many people are continuously learning how to use them properly.
However, some individuals or businesses take advantage of the anonymity of crypto to hide income or evade taxes. Large transactions or significant transfers timed around tax season can signal potential abuse or crypto tax underreporting.
In addition, cryptocurrency transactions often involve complex tax implications, including reporting requirements for capital gains, losses, and income derived from trading or investment activities.
7. Claiming Excessive Education Credits
The IRS recognizes two types of education credits—the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). These credits help you with higher education costs by lowering the tax you owe.
Not everyone is qualified to claim these credits. Taxpayers must meet income limits, education requirements, and other eligibility rules to qualify for credits claimed. Even the school should be accredited and eligible to participate in student aid programs.
Sometimes, the school’s filings contain a small error, like a missing Form 1098-T Tuition Statement or your name spelled incorrectly. That could trigger an IRS audit. Keep records of tuition statements, Form 1098-T, and other documentation to validate education credit claims.
8. Foreign Bank Accounts and Foreign Income
U.S. taxpayers are allowed to keep foreign accounts. However, they must be fully transparent with reporting and compliant with foreign and local asset-reporting laws. The IRS audits significant offshore activities due to the potential for tax evasion and money laundering.
Major audit triggers include incomplete documentation of foreign accounts, missing offshore income reports, and undeclared assets in foreign jurisdictions.
9. Incorrectly Reporting Alimony Payments
The IRS closely monitors alimony reporting to ensure payments qualify for deductions, match amounts received, and are not being misreported to avoid taxes. Taxpayers who claim alimony deductions may be subject to audit selection to ensure compliance with tax laws and regulations.
If the IRS sends you a letter questioning your alimony deductions, you need proof like divorce decrees, canceled checks, and payment records to validate alimony deductions.
10. Early Retirement Account Withdrawals
Taking distributions from retirement accounts, such as IRAs or 401(k)s, before reaching the age of 59½ generally incurs penalties and taxes. You can skip these costs if you qualify for an exception, but the IRS might need to verify the validity of your exception with an audit.
Other red flags may include excess contributions, unreported retirement accounts, and prohibited transactions such as using retirement funds as loan collateral.
11. Dependents Claimed Incorrectly
Incorrect dependent claims are a major area of IRS audits. Taxpayers must meet the criteria to claim dependents. The IRS may audit returns to verify dependent eligibility and ensure taxpayers follow dependency rules in tax law.
When multiple taxpayers claim the same dependent, like divorced parents, the IRS may audit both. They determine who can rightly claim the dependent based on custody arrangements and support provided.
12. Not Reporting Gambling Winnings or Losses
Gambling winnings, including winnings from casinos, lotteries, raffles, and other games of chance, are considered taxable income by the IRS. Taxpayers who fail to report gambling winnings may be selected for audit. The IRS does this to ensure tax compliance and collect owed taxes.
Taxpayers who claim gambling losses must also have detailed records to substantiate deductions if audited.
13. Large Refunds
The IRS looks at tax refund consistency. Did you report income or tax liability that generated oversized refunds in prior years? Claiming unusual refund amounts—significantly larger or lower than previous years—may raise suspicion and trigger an audit.
Auditors would request documentation to support reported income sources, deductions, credits, and other tax-related items.
14. Day Trading Activities
Day trading is not illegal or unethical, but it is complicated tax-wise. Overtrading can also have a serious impact on your taxes. Day traders buy and sell securities frequently, sometimes multiple times within a single day. The IRS scrutinizes these high-volume trading activities to ensure accurate reporting of gains, losses, and taxable income.
Traders can pass any IRS audit if they’ve proven to comply with tax laws, maintain records of all day trading activities, and report day trading transactions accurately.
15. Excess Rental Property Losses
The IRS allows loss write-offs for individuals or businesses with rental properties. However, the IRS verifies through an audit if the reported deductions of taxpayers with consistently high rental property losses are valid, supported, and comply with rental property tax rules.
16. Claiming a Large Number of Tax Credits
Tax credits are valuable incentives the government provides to encourage specific behaviors or activities, such as education expenses, childcare costs, or energy-efficient home improvements.
While tax credits can significantly reduce a taxpayer’s tax liability, some taxpayers could mistakenly claim a large number of tax credits or intentionally attempt to exploit tax credit provisions. Either way, this could raise red flags for the IRS. Through audits, the IRS will check discrepancies or irregularities and take appropriate enforcement actions to address non-compliance with tax laws.
17. Casualty Loss Claims
If taxpayers included losses from a sudden, unexpected event like a natural disaster, accident, theft, or other casualties on their tax returns, they should have sufficient documentation.
The IRS often triggers an audit to verify if the claims stemmed from legitimate, documented sudden events before allowing these unusual loss deductions.
18. Unfiled Previous Tax Returns
The IRS expects returns to be filed on time every year. Missing returns raise suspicions of unreported income. Sometimes, the IRS sees unfiled previous tax returns as a sign of possible fraudulent activity, which could lead to a detailed tax audit.
The IRS will continue to assess any outstanding tax liabilities and address penalties until the matter is resolved.
19. Claiming Energy Credits
There are numerous eligibility requirements and limits to the amount of energy credits that you can claim. Due to the complexity of program rules, energy credits have a high improper payment rate.
Through an audit, the IRS scrutinizes returns claiming energy credits to ensure the claimed energy-efficient improvements meet the criteria. Taxpayers must provide supporting documentation to substantiate their claims.
20. Numerous Math Errors, Rounded Numbers, and Estimates
The IRS relies on accurate financial data to assess tax liabilities correctly. If a taxpayer submits a tax return with numerous math errors, rounded numbers, and estimates, it could attract the scrutiny of the IRS due to concerns about accuracy and compliance.
21. Large Cash Transactions Without Proper Documentation
Large cash transactions that are not properly documented raise suspicions because they can indicate attempts to conceal income. The IRS audits taxpayers with cases like this to identify unreported income and ensure they accurately fulfill their tax obligations.
22. High Self-Employment Income
A self-employed person runs a business, so you must pay federal, state, and local taxes. Taxpayers with high self-employment income may claim various deductions and credits related to business expenses, retirement contributions, health insurance premiums, and other expenses. They may be requested to verify the eligibility and substantiation of these deductions and credits.
23. Moving States to Avoid Higher Taxes
Moving states to avoid paying higher taxes can potentially trigger an audit due to the significant financial implications involved. Tax authorities are vigilant about ensuring compliance with tax laws, and sudden changes in residency for tax purposes can raise red flags.
When individuals or businesses relocate to a new state primarily for tax reasons, tax authorities may scrutinize their actions to determine if the move is genuine or merely a ploy to reduce tax obligations.
Ryan Furlong, CFP and Wealth Advisor at PurposePath Capital, explains:
“In my experience, several factors can increase the likelihood of triggering an audit on your taxes. One of the biggest Red Flags to the IRS? Moving states specifically to avoid paying higher taxes. Especially if the move seems to lack substantive evidence of a genuine relocation.
If a tax authority suspects that your change of residency is merely on paper to evade taxes without a corresponding change in domicile, it could trigger an audit. The authorities will look at various factors, including the amount of time you spend in each state, the location of your primary family home, where you are employed, and where your vehicles are registered. They check cell phone pings and credit card statements – don’t let the internet fool you when it comes to this “tax strategy” as it’s the quickest way to get audited.”
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