The most audited tax situations often involve certain red flags that the IRS looks for due to potential discrepancies or common areas where tax evasion or errors might occur. Based on information available from various sources, here are some scenarios that tend to attract IRS scrutiny:
High Deductions Relative to Income:
If deductions taken are significantly disproportionate to the reported income, this can trigger an audit. For instance, claiming a very high amount in charitable donations or business expenses relative to income can raise eyebrows.
Self-Employment and Business Losses:
Self-employed individuals, particularly those reporting business losses year after year on Schedule C, are more likely to be audited. The IRS may question the viability of a business that consistently shows losses.
Earned Income Tax Credit (EITC):
Low to moderate-income taxpayers claiming the EITC are statistically more likely to be audited than others. This is partly because of the complexity involved in qualifying for the credit and the potential for errors or fraud.
High-Income Earners:
Individuals reporting over $10 million in income have a significantly higher audit rate. This is due to the complexity of their tax situations and the potential for larger revenue recovery.
Foreign Income and Offshore Accounts:
Tax returns that involve income from foreign sources or those reporting foreign bank accounts are more likely to be audited due to the IRS’s focus on international tax compliance.
Cryptocurrency Transactions:
With the rise of cryptocurrency, those trading in crypto without properly reporting transactions can face higher scrutiny, especially if there’s a mismatch between reported income and known transactions.
Large Cash Transactions:
Businesses or individuals dealing with large amounts of cash, particularly if they report cash payments of $10,000 or more, might attract audits because cash transactions can be harder to trace.
Rounded Numbers and Errors:
Tax returns with rounded numbers for expenses or income might suggest estimation rather than precise record-keeping, which can be a red flag. Additionally, mathematical errors or discrepancies with third-party documentation (like W-2s or 1099s) increase audit risk.
Amended Returns:
While amending a return to report additional income generally doesn’t increase audit risk, amending to significantly reduce tax liability might.
Partnerships and S Corporations:
Complex business structures like partnerships or S corporations can lead to closer IRS examination due to the potential for income distribution manipulation.
These situations highlight where the IRS might see potential for noncompliance or errors, leading to an increased chance of audit. However, it’s also important to note that the IRS uses both random selection and sophisticated algorithms to choose returns for review, so even returns without these red flags can be audited. To reduce the risk of an audit, it’s advisable to keep meticulous records, report all income accurately, and ensure all deductions are substantiated.
Remember, the information here is based on general trends and patterns observed in tax compliance. Individual circumstances can vary, and not all audits are based solely on these factors. If you’re concerned about your specific tax situation, consult with us today.