The Top 12 IRS Audit Triggers
1. The Computer Trigger
The IRS has a Discriminant Information Feature (DIF) computer system that is explicitly designed to detect tax return anomalies. It scans each tax return received by the IRS. DIF looks for items like duplicate data, maybe two or more individuals claiming to be the same dependent, as well as deductions and credits that just don't make sense.
Each return is measured by the machine to that of other taxpayers who earned roughly the same income. For instance, most individuals who earn $40,000 a year don't give a charity $30,000 of that money and take a deduction for it because if you do, DIF is almost guaranteed to throw a flag. The flag of the DIF prompts human agents' analysis.
2. You Earn a Lot…or Very Little
If agents are fairly sure that the taxpayer owes additional taxes and there is a reasonable possibility that the IRS will recover that money, the IRS would not spend its time on an audit. This puts a premium on earners with high incomes.
Many of the audited returns were for taxpayers making $500,000 a year or more, with most of them earning more than $1 million in taxes. These are the only sales ranges that in 2018 were subject to more than a 1% risk of an audit.
Conversely, if you try to take out all or much of your taxes with the use of tax deductions, you have a better risk of being audited. In 2018, only 1.1% of taxpayers receiving between $500,000 and $1 million were audited, while 2.04% of those who reported no adjusted gross revenue were under the microscope of the IRS.
3. You Overlooked Income
For your earnings, your employer must issue a W-2 and also send a copy to the IRS. Forms 1099-MISC are issued by independent contractors and freelancers, usually when they are paying more than $600 for services, and the IRS often gets copies of these.
If you have interest or dividend income and, yes, the IRS gets a copy, you can expect a Form 1099-INT or 1099-DIV at the end of the year. You can even assume that if you win big at the casino or hit the lottery, you and the organization will obtain a Form W-2G.
Both of these types of information are fed into DIF, so if the tax return fails to contain either of these sources of income, the flag goes up.
With a few exceptions, any revenue you earn is taxable and must be registered, including tips, the money you have been charged for services, or income that falls below the $600 mark so that Form 1099-MISC does not require it You will have to pay taxes on it.
Thanks to the Tax Cuts and Jobs Act, Alimony is an exception as of Jan. 1, 2019 (TCJA). It is no longer mandatory for spouses earning alimony to disclose it and pay tax on that money.
4. You Spent or Deposited a Lot of Cash
Different types of companies are required under the Bank Secrecy Act to alert the IRS and other federal agencies if someone participates in major cash transactions costing more than $10,000. The concept is to foil illegal operations. A side effect is that if you plunk down or deposit a lot of cash for some reason, particularly if your recorded income doesn't justify it you might expect the IRS to wonder where that money came from.
If you make a large deposit exceeding this number, the IRS will be informed. If you file a tax return, you should be prepared to demonstrate how and why you got the money.
For banking and financial institutions, these reporting rules often enforce time limits. If you deposit an extra $1 or more on Tuesday, a $9,999 deposit on Monday could be registered. In this scenario, the IRS claims you're "structuring" your deposit, and there are laws against this too.
5. You Claimed a Lot of Itemized Deductions
The IRS wants taxpayers to work within their wealth. They're earning, they're paying their bills, and maybe they're lucky enough to even save and spend a little money. If you're spending and claiming tax deductions for a large part of your income, it may cause an audit.
When taxpayers itemize, this trigger usually comes into play. Mother Teresa may have been able to get away with giving charity 75 percent of her profits, but for most people, that is just not a practical scenario. Similarly, if you argue that you spend a great deal on mortgage interest when you really don't earn enough to qualify for such a large mortgage based on your recorded income, that situation would also raise concerns.
If you give away something that is priced at more than $500, avoid trouble by having the item appraised, obtaining a receipt, and filing Form 8283 with your tax return.
6. You're Self-Employed
A host of tax deductions that most other taxpayers do not get to share are entitled to sole proprietors and freelancers, such as home office deductions, mileage deductions, and meal, ride, and entertainment deductions. To assess your taxable income from your company, these expenses are measured on Schedule C and are deducted from your earnings.
DIF is looking for deductions for different occupations that are above the average. If you're an art dealer, you may be expected to spend 15 percent or so of your income on travel each year, because that's what most art dealers spend. If you say 30 percent, you should possibly expect the IRS to take a closer look at your return.
7. Your Business Is Home-Based
The IRS understands that taxpayers who seek deductions from home offices sometimes have the laws incorrect, so there are probably some extra tax dollars to be had here.
The ironclad rule is that for business, and only business, you must use your home office place. You and the members of your family simply can't do anything else in that room. If you are trying to demand a deduction for a home office, check IRS Publication 587. You'll want to get the right one for this.
8. You Own a Cash Business
Operating the main cash business, no one issues you 1099s for your services, but instead, they hand over $50 for the haircut, they can also place you on the IRS radar.
According to the IRS, businesses that fall into this category include salons, restaurants, bars, car washes, and taxi services. Perhaps unfairly, the government takes the stance that stuffing those $50 bills into their pockets and forgetting about them at tax time is very convenient for the owners of cash businesses.
9. You Claim Your Hobby as a Business
If you're self-employed, you'll get all those neat Schedule C tax deductions, but you're pretty much out of luck if your company is a hobby. It used to be that if you itemize, you may subtract expenditures up to the amount of income you earned from your endeavor, but this deduction has been abolished by the TCJA, at least by 2025.
Your hobby is not a business if in at least three of the last five tax years you haven't shown a net profit from it. If you are breeding horses, there is an exception In this situation, it is two out of seven years. You can file Form 5213 to give yourself four more years to make a profit if you're just starting out and this is your first year at your company, but this can also prompt a closer look by the IRS.
10. You Have Assets or Cash in Another Country
It's a huge one here. The IRS is particularly interested in taxpayers who in other nations have assets and cash stashed, especially in countries with more favorable tax laws than those in the U.S. As well as its inspection of such tax returns, the IRS has ramped up its overseas asset rules.
Typically, the IRS will access your account details from a foreign bank, and it will do so if it thinks you may owe taxes on the money you put in there. In fact, some foreign banks have a duty to provide lists of American account holders to the IRS.
You are obliged to disclose on FinCEN Form 114 all foreign accounts with total accumulated balances of more than $10,000. On IRS Form 8938, foreign assets valued at $50,000 or more must be registered. If you do so, you can comply with tax law, but you can also expect the IRS to verify and ensure that your account balances are really what you have claimed to be.
11. You Have Investment Income
Remember, copies of all data returns containing the Social Security number are obtained by the IRS. Some of them, particularly when you have investments, can be all too easy to forget or misunderstand. For those 1099 forms that will arrive after the first of the year, keep an eye out because it will be the IRS.
If the IRS receives 1099 stating that you have been paying interest or dividends, and if your tax return does not mention the interest or such dividends, you will receive a letter from Washington asking about it. However, if you actually agree to the revenue change and pay the bill, the letter does not proceed to a full-blown audit.
12. You Claimed the Earned Income Tax Credit (EITC)
It is something of an automatic audit trigger to claim the Earned Income Tax Credit, but you probably won't even know that your return is being checked by the IRS.
The EITC is a refundable tax credit that rises as the number of dependent children you have increased. For qualifying, there are revenue caps as well. If you're entitled to claim the EITC and the amount of credit you apply for is more than any tax you owe, the IRS sends you a check for the difference.
But before making completely sure you are actually eligible to claim those dependents and that the income you are declaring is correct, the government does not want the IRS to do that. Consequently, The Protecting Americans from Tax Hikes (PATH) Act forbids the IRS from granting refunds before mid-February to any taxpayers who demand this credit. This provides the department with time to monitor these returns to ensure that everything is up-and-up.
The same rule applies to the Additional Child Tax Credit.
Are you terrified of you, your business, or your non-profit getting audited by the IRS? Do you wake up in the middle of the night at the thought of hearing that knock on your door? Call Robert Arnone CPA today so you can get busy relaxing tomorrow! We also handle internal audits, of course. We specialize in helping HOAs, non-profits, small and mid-sized businesses make sure their books are in order so business leaders can sleep better at night. So if you’re even a little concerned, now is the time to act. Contact us today!