5 Red Flags That Could Trigger an IRS Audit

Mar 16, 2024

While most tax returns are accepted without issue by the IRS, there are certain things that can increase your chances of having your return pulled for further review or an audit. Despite the fear an audit notice can instill, the IRS approach to selecting returns isn’t personal – it relies on random sampling, computerized screening for anomalies, and checking returns against income information documents they receive.

The goal of an IRS tax audit is to ensure taxpayers are accurately reporting their income, expenses, deductions and credits. When inconsistencies are found, it can result in you owing additional taxes, receiving a refund, or potentially even facing penalties. In fiscal year 2022 alone, the IRS conducted over 708,309 audits resulting in nearly $30.2 billion in additional taxes assessed.

So what raises those dreaded red flags? Here are five common triggers that could lead to an IRS audit or tax notice:

1. Math Errors : This is one of the most frequent issues the IRS encounters, with the agency sending out close to 16 million math error notices in 2022 alone. The top culprits were mistakes made on returns claiming the Economic Impact Payment/Recovery Rebate Credit and the Child Tax Credit.
While a simple math mistake may not necessarily lead to a full-blown audit itself, if your return gets manually reviewed and other issues are identified, it could prompt the IRS to take a deeper look. The easiest way to avoid these errors is to e-file your return and double check your figures.

2. Failing to Report All Income: Through the Automated Underreporter program, the IRS compares the income and information documented on your tax return to the W-2s, 1099s and other income documents they receive from employers, banks, investment firms and other sources. If there’s a discrepancy between what you reported and what the IRS has on file, you’ll likely receive a CP2000 notice.
In 2022, this program resulted in 1.6 million cases being flagged with over $8.7 billion in additional taxes assessed. A notice doesn’t necessarily mean you’ll be audited though – you may just owe additional taxes or even be due a larger refund if income was underreported.

3. Excessive or Questionable Deductions: While you should absolutely claim all the deductions you’re entitled to, the IRS looks for red flags when deductions seem excessive compared to your income level. For example, if you report $40,000 of income but claim $10,000 in charitable contributions, that may appear out of the ordinary and lead to further examination.
The IRS compares deduction amounts taken on your return to “norms” for other similar returns. If yours has a deduction pattern that differs greatly from what’s typical for your income bracket and filing status, it could get flagged.

4. Overstating Business Expense Deductions: There’s a common misperception that you can write off personal costs just by conducting minor business activities. However, the IRS has strict criteria on what qualifies as an ordinary and necessary business expense. Trying to claim too much could be seen as abusing business deductions.
Some examples that tend to raise red flags – deducting the full costs of a vacation by tacking on a small bit of business, or writing off a personal vehicle’s entire cost despite only using it rarely for business purposes. Before claiming anything questionable as a business expense, consult IRS guidance and possibly a tax professional.

5. Showing a Pattern of Consecutive Hobby Losses: While it’s understandable that a small business may take a couple years to get profitable, the IRS looks askance at individual business activities that continually generate losses year after year. There are strict rules about being able to deduct losses from a “for profit” enterprise versus a hobby or recreation activity you don’t pursue in a businesslike manner.

If your side gig or small business shows consistent losses with no path to eventual profitability, the IRS could disallow your deductions and require you to treat the venture as a hobby instead of a business. You’ll want to carefully document and prove your profit motivations to avoid having losses disallowed.

The Bottom Line

While the fear of an audit is very real for taxpayers, taking care to file accurately, report all income, and stay within the bounds for legitimate deductions reduces your risk significantly. If you do happen to get an IRS notice or audit letter, don’t panic. Respond promptly, provide documentation if requested, and work to resolve any substantiated issues.

And importantly, don’t let audit anxiety lead you to leave money on the table. If you qualify for credits, deductions or other tax benefits, claim them properly on your return. Just be judicious, keep excellent records, and ensure your return bears up under scrutiny.

By being meticulous in your tax return preparations and filings, you can minimize your chances of the IRS deciding to take a closer look. But remember, some audits happen completely at random too. The best approach is to be fully compliant and have your documentation ready just in case. Then you can file with confidence each year.