5 Most Common IRS Audit Red Flags

In this article, we discuss 5 most common IRS audit red flags. If you want to read our detailed analysis of auditing practices in the US, go directly to read 20 Most Common IRS Audit Red Flags.

5. Inconsistencies on Tax Returns

When reviewing tax returns, the IRS compares the information provided by taxpayers with other sources of data, such as W-2 forms, 1099 forms, and other third-party reports. If there are significant disparities or inconsistencies between the reported income, deductions, credits, or other tax-related items on your return and the information available to the IRS, it can raise suspicion and potentially lead to an audit.

4. Prior Audit History

Having a prior audit history does not necessarily mean that you will be audited again for subsequent tax years. However, if the IRS has identified issues or discrepancies during the previous audit, it may increase the likelihood of being selected for an audit again in the future. Over the years, the audit rates have decreased significantly with the IRS auditing 3.8 of every 1,000 income tax returns in 2022. One of the main reasons for this decline is that funding for the agency fell by 20% between 2010 through 2019.

3. Cash-Intensive Businesses

Businesses that primarily deal in cash transactions, such as restaurants, bars, and small retail establishments, are at higher risk of audit due to the potential for unreported income. According to a report by the Department of the Treasury, three men were sentenced for carrying out a money laundering scheme through an auto dealership located in Illinois, US.

2. Large Charitable Contributions

Claiming significant charitable contributions relative to your income may raise suspicions. In this regard, unconventional or non-cash contributions, such as donating highly appreciated assets, intellectual property, or complex securities, can raise red flags. These types of donations may require additional documentation to substantiate their value and eligibility for deduction. Recently, Miami’s socialites were investigated by the IRS over a yacht donation that cost them $3.5 million in taxes and penalties, reported by Wall Street Journal.

1. Self-employment Income

Self-employed individuals have more opportunities for unreported income or exaggerated deductions, making them a focus for potential audits. Sole proprietorship and partnership are the simplest forms of self-employment and can potentially lead to underreporting income. According to Brookings Institution, over 60% of farm and sole proprietorship income is not reported to the government.

You can also take a look at 15 States That Don’t Tax Social Security Or Pensions and States With the Lowest to Highest Capital Gains Tax Rate