Common reasons the IRS may audit you

What triggers IRS audits?

There are a variety of reasons why the IRS audits someone. Most audits are triggered either by random sampling or the income document-matching program. The document-matching program verifies the income and amounts reported to IRS are on the return and that the amounts match.

There are also circumstances that may cause the IRS to examine your return more closely. For example, the IRS may request more information if your itemized deductions are very high, or if you claim excessive small business losses. The IRS may also ask you to explain the treatment of an item on your tax return.

Many examinations result in a refund or acceptance of the tax return without change, but some may result in a change in tax liability, meaning you’ll end up owing the IRS.

What causes an IRS audit?

As mentioned above, there are different causes for an audit. While the IRS doesn’t share an exact science or formula for which taxpayers will get audited, there are some common items that raise red flags within the IRS systems. These are potential signs that a tax return may require additional information to verify the accuracy of the tax return. We go into detail about a few key reasons below.

It is important to note that you must report all taxable income you receive, even if you don’t receive a 1099 or other document. You should receive all the forms by the end of January of that tax year.

Unreported income

As you can imagine, this is a big no-no for the IRS and one of the biggest reasons a return gets flagged for an audit. It’s generally easy for the IRS to know when you have income that you haven’t reported because—as mentioned above—they receive your W-2s and 1099s. They can compare if what you reported is what is reported in official statements from your employers, clients, or other companies from whom you derived income. Being honest is always important.

It is important to note that you must report all taxable income you receive, even if you don’t receive a 1099 or other document. You should receive all the forms by the end of January of that tax year.

Excessive deductions and credits

Another red flag for the IRS is if the deductions, losses, or credits on your return are disproportionately large, compared with your income. Again, it’s important to be as accurate as possible with all the credits and deductions you’re taking for yourself and your family. You’ll want to document anything you’re looking to write off at tax time.

As with all these reasons, being as honest as possible and keeping as much proof as possible will save you a lot of stress in the long term.

Rounding up numbers

When claiming tax breaks, it’s important to use accurate numbers rather than rough estimates on your return, experts say. Round numbers indicate you’re estimating or perhaps even fudging the numbers. This is a big red flag for the IRS.

Always keep your receipts and make sure that you enter in the amounts as close to the exact number as possible. If you’re audited, make sure that you have all the paperwork on hand to help reconcile any discrepancies.

Foreign transactions and accounts

Offshore assets and income have been a major trigger for IRS audits for a long time. The U.S. Treasury loses billions of tax dollars each year due to offshore transactions that do not get reported or are reported inaccurately. The IRS continues to focus on these areas with audits.

Cryptocurrency transactions

The emergence of cryptocurrencies, like Bitcoin and others, has been a recent focus of the IRS. The IRS requires more disclosure of crypto accounts on a tax return. Because there is little or no audit trail associated with digital currency, the IRS targets taxpayers with cryptocurrency for audits.

Small businesses and gig workers

Small businesses and gig workers are responsible for reporting their own income and deductions on their return. The IRS believes, from its tax gap studies, that these taxpayers have a 55% or greater rate of not reporting their income and deductions accurately. For this reason, many of these Schedule C filers (and even Schedule E filers) are targeted for audit. Common issues the IRS looks for are unreported income and deductions of personal expenses.

There are also many other reasons that you could be subject to an audit. The IRS has many industries or transactions that they routinely select for audit due to perceived noncompliance. For example, the IRS may select rental property owners for audit because they believe they underreport income. Another audit trigger is an informant--that is, someone who turns in a taxpayer for noncompliance. The IRS reviews the informant’s claim and may select the person for audit based on the facts presented.

How to handle IRS tax audit?

The IRS audit notice may either require you to attend a meeting in person, or to send additional information by mail. Usually most audits are “mail audits” and not “face-to-face audits.”

You should answer the IRS as soon as you receive a notice. Don’t ignore it or put it off since this only makes it worse. It’s important to note that Jackson Hewitt cannot act as your representative or financial representative.

If the examination results in a change to your tax liability, you may want the IRS to appeal your case. The IRS may reconsider your case if you are submitting additional information that could result in a change to the additional amount they determined that you owe, you are filing an original delinquent return after they determined that you owe an additional amount, or you have identified a mathematical or processing error they made.

You should gather copies of your records, tax returns, canceled checks, and any other necessary information to support your case. Your reasons for disagreeing cannot be based only on moral, religious, political, constitutional, conscientious, or similar grounds.

If you cannot reach an agreement regarding the proposed changes to your tax return, the IRS may send you Letter 525, General 30-day Letter, notifying you of your right to appeal, a copy of the tax examiner's report, and an agreement or a waiver form. If you do not respond to this letter, or if you still do not reach an agreement with the appeals officer, the IRS will send you a Letter 531, Notice of Deficiency. You have 90 days from the date of this notice to file a petition with the Tax Court. If you do not file this petition, you will receive a bill for the amount.

What are the typical outcomes for tax audits?

An audit usually has one of these three possible outcomes:

• No change: an audit in which you have substantiated all of the items being reviewed and results in no changes.
• Agreed: an audit where the IRS proposed changes and you understand and agree with the changes.
• Disagreed: an audit where the IRS has proposed changes, and you understand but disagree with the changes.

What are the chances of getting audited?

Although it’s scary, it is quite rare to get audited. You should not live in fear because few people are at risk of an IRS audit. According to IRS data from 2022, 0.39% of taxpayers are at risk of an IRS audit. As mentioned above, if you do get audited, our Tax Pros can help you.

What happens if I don’t pay?

Before we end the article, it’s important to understand the penalties in an audit. The most common penalty is an accuracy penalty. Generally, accuracy penalties are 20% if you are negligent or make a substantial understatement of tax. If the IRS finds that you committed fraud, the civil penalty is 75% of the additional tax owed. If fraud is present, the IRS can also pursue criminal prosecution. Most taxpayers who make attempts to comply are never subject to criminal penalties.

If you receive an IRS notice of an audit, try to remain as calm as possible and always make sure to be as accurate and honest as possible when filing your tax return. You can learn more about owing issues with the IRS here.

About the Author

Mark Steber is Senior Vice President and Chief Tax Officer for Jackson Hewitt. With over 30 years of experience, he oversees tax service delivery, quality assurance and tax law adherence. Mark is Jackson Hewitt’s national spokesperson and liaison to the Internal Revenue Service and other government authorities. He is a Certified Public Accountant (CPA), holds registrations in Alabama and Georgia, and is an expert on consumer income taxes including electronic tax and tax data protection.

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