Key Takeaways
- The IRS uses a combination of automated and human processes to select which tax returns to audit.
- Not reporting all of your income is an easy-to-avoid red flag that can lead to an audit.
- Taking excessive business tax deductions and mixing business and personal expenses can lead to an audit.
- The IRS mostly audits tax returns of those earning more than $200,000 and corporations with more than $10 million in assets.
Red flags
The Internal Revenue Service (IRS) uses a combination of automated and human processes when selecting which tax returns to audit. All tax returns are compared with statistical norms, and those with anomalies undergo three layers of review by personnel.
IRS tax audits then occur either by mail, or through an in-person meeting at either the taxpayer's:
- home
- place of business
- accountant's/representative's office
They can be unpleasant and are sometimes unavoidable. Certain red flags are sure to draw scrutiny and some are easy to sidestep—unreported income, for example. Others, such as high income, can’t be helped. And some flagged returns aren't audits at all, they're simply IRS identity verification checks.
Let's take a look at four common audit red flags.
1. Not reporting all of your income
Unreported income is perhaps the easiest-to-avoid red flag and, by the same token, the easiest to overlook. Any institution that distributes an individual’s income will report it to the IRS, and the more income sources you have, the greater the difficulty in keeping track.
Old brokerage accounts are commonly overlooked, as are Form 1099s and distributions from a college savings account to pay tuition. Learn more if you find yourself asking if I forgot to file a 1099 can I file it next year?
- The IRS will typically receive a copy of all the tax forms that you receive, including distributed income.
- The IRS will match the reported items to a person’s return. If they see something missing, they will automatically conduct at least a correspondence audit, which is conducted by mail or over the phone.
2. Breaking the rules on foreign accounts
The Foreign Account Tax Compliance Act has strict reporting requirements for foreign bank accounts.
- The law requires overseas banks to identify American asset holders and provide information to the IRS.
- Individuals are required to report foreign assets worth at least $50,000 on last day of the tax year, or $75,000 at any time during the tax year on Form 8938 (at least $100,000 on last day of the tax year, or $150,000 at any time during the tax year, for married couples filing a joint tax return).
It used to be you didn’t have to report it; you just had to check a box that you had one. Now you have to not only check the box, you have to identify the institution and the highest dollar amount the account was at the previous year.
The regulations demand openness, which in turn increases the likelihood of an audit. That’s because of a perception that taxpayers with foreign accounts are trying to hide income offshore. Learn more about foreign bank account reporting and what FBAR filing requirements mean for you.
But it’s a Catch-22: Compliance with the law increases the likelihood of an audit, and noncompliance can result in stiff penalties and significant legal liabilities.
3. Blurring the lines on business expenses
The IRS will look more closely at business tax deductions that appear to be excessive.
- The agency uses occupational codes to measure typical amounts of travel by profession, and a tax return showing 20% or more above the norm might get a second look.
- Also, take-home vehicles aren’t considered strictly business, so a specific purpose should accompany any vehicle-related deduction.
Generally speaking, the IRS can be strict about mixing business and personal expenses. Business meals can be allowable, but exceeding the occupational norm by a great amount invites an audit. Business meals oftentimes can be a blurred line, so be sure to document what is and isn't a personal expense.
TurboTax Tip:
Individuals must report foreign assets worth at least $50,000 on the new Form 8938. Failing to report foreign assets can lead to an audit.
4. Returns with high earnings
The audit rate is higher for people with a very high income. For instance, according to IRS data, the IRS only audited 0.36% of all individual tax returns filed for the 2015 through 2023 tax years. However, during that same time period, the audit rate jumps to 7.9% for returns reporting total income of $10 million or more.
Higher incomes are also likely to result in more complex tax returns, which are more likely to contain other audit triggers.
TurboTax has you covered
When you file your taxes with TurboTax, you automatically receive access to our Audit Support Center for help understanding your IRS notice, what to expect and how to prepare for an audit, and finding year-round answers to your audit questions. The TurboTax Audit Support Guarantee also includes the option to connect with an experienced tax professional for free one-on-one audit guidance.
For those who want even more protection, TurboTax offers Audit Defense, which provides full representation in the event of an audit, for an additional fee.
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