Most of us aren’t out here actively trying to break tax laws or get on the bad side of the IRS. But if you’re around long enough and make enough money, you could eventually find yourself in the crosshairs of the IRS for inadvertently doing something wrong (or misinterpreting a rule). And that’s not a place you want to be.
So, how do you avoid triggering an IRS audit? Understanding the red flags that auditors look for can help you be more careful and avoid issues. Here are five of the biggest red flags that IRS auditors watch for when reviewing tax returns.
Underreporting Income
Whether intentional or accidental, leaving out any source of income on your tax return is a huge red flag. The IRS receives reports from various sources, including employers, financial institutions, and even gig platforms. If the income you report doesn’t match the forms they have on file, it will raise suspicions.
For example, if you’re a freelancer and don’t report all your income from 1099 forms, the IRS will notice the discrepancy. Similarly, if you’re working a side hustle and don’t report that income, you’re putting yourself at risk. Even small amounts of unreported income can lead to significant penalties, so make sure you’re thorough in reporting every source of income, no matter how minor it seems.
“Ensuring you report all sources of income—including tips, cash payments, and payments over Venmo and other cash apps—will help prevent an IRS audit and penalties,” according to the white collar criminal law attorneys at SBBL Law.
Claiming Excessive Deductions or Credits
While taking advantage of tax deductions and credits is perfectly legal, claiming excessive or unrealistic deductions is a major red flag. If your deductions are significantly higher than what’s typical for someone with your income, the IRS may take a closer look.
What does this look like in the real world? Well, if you claim unusually high deductions for charitable donations, business expenses, or home office use, the IRS might question whether those claims are legitimate. The IRS compares your return to others in similar tax brackets, and if something stands out as abnormal, it could trigger an audit.
Additionally, some tax credits, like the Earned Income Tax Credit (EITC), are often abused. While qualifying for credits is great, inflating your claims to reduce your tax bill can lead to serious consequences. It’s important to follow the rules and keep documentation that proves your deductions and credits are accurate.
The best way to avoid this red flag is to only claim deductions and credits that you can back up with proper documentation. Keep receipts, invoices, and any other relevant records that support your claims. That way, if the IRS questions you, you’ll have the proof you need.
Maintaining Poor Records
Inaccurate or incomplete records are another major red flag for IRS auditors. The IRS expects taxpayers to keep detailed records that back up all of the information on their tax returns. If your records are sloppy, inconsistent, or absent, the IRS may suspect that you’re either hiding something or being careless with your tax filings.
To avoid this red flag, get organized. Keep detailed, well-organized records for your income, expenses, and deductions. Use accounting software or apps to track your business expenses, save receipts, and organize them in a way that’s easy to retrieve in case of an audit.
Discrepancies Between Income and Lifestyle
Another thing IRS auditors watch for is when a taxpayer’s reported income doesn’t match their lifestyle. If you’re reporting a relatively low income but living a lifestyle that suggests much higher earnings – like buying luxury cars, taking expensive vacations, or owning multiple properties – the IRS may become suspicious and question how you’re funding that lifestyle.
For example, if you report a modest annual income but own a high-end home or frequently purchase luxury goods, the IRS might wonder if you’re hiding income or engaging in illegal financial activity. They could investigate to see whether you’re underreporting income or avoiding taxes through other means.
The best way to avoid this red flag is to report all of your income accurately and keep thorough records of any financial assistance or gifts you receive that might explain larger purchases. Transparency is key – if your financial situation is complex, consider consulting with a tax professional who can help you navigate the details.
Frequent Amendments to Tax Returns
Everyone makes mistakes, and occasionally amending your tax return is fine. However, if you frequently amend your returns, especially for significant changes, it can catch the attention of the IRS. Consistently changing your return can make it appear as though you’re either intentionally misstating your finances or being careless in preparing your taxes.
For instance, if you’re constantly submitting amended returns to adjust your income, deductions, or credits, the IRS might take a closer look to ensure that you’re not trying to game the system. While amending your return is sometimes necessary, doing so too often can raise red flags.
To avoid this, it’s crucial to get your tax return right the first time. Double-check your information before filing, consult a tax professional if needed, and ensure that everything is accurate. Only file an amended return when necessary and be sure that you have a legitimate reason for making the changes.
Adding it All Up
While the IRS has the freedom to audit whoever it wants – and will often randomly audit people as a way of making sure they’re staying on top of things – you can significantly reduce your chances of being audited by knowing what they look for – and being sure not to trigger any of those red flags.