5 Common IRS Audit Triggers and How to Avoid Them

Want to avoid an IRS audit? Here’s what you need to know: IRS audits are often triggered by specific red flags in your tax return. These include mistakes in reporting income, questionable deductions, errors with tax credits, self-employment issues, and major financial transactions like foreign accounts or cryptocurrency.

Quick Tips to Avoid IRS Scrutiny:

• Report Income Accurately: Double-check W-2s, 1099s, and other forms to ensure everything matches.
• Keep Records of Deductions: Back up claims for home office, vehicle expenses, or charitable donations with detailed documentation.
• Avoid Errors in Tax Credits: Know the rules for claiming dependents and ensure your filing status is correct.
• Watch Self-Employment Claims: Keep accurate records for Schedule C and avoid claiming excessive deductions.
• Report Major Transactions: File required forms for foreign accounts or cryptocurrency and maintain detailed records.

Audit rates are low overall (0.44%) but rise significantly for high earners. Stay organized, file accurately, and consult a tax professional for complex situations to reduce your audit risk.

Trigger 1: Wrong Income Reports

Income Reporting Errors

Mistakes in reporting income are one of the top reasons for IRS audits. The IRS relies on automated systems to match the income you report on your tax return with the data provided by third parties, like W-2s and 1099 forms. If there’s a mismatch, it raises a red flag.

Here are some common income reporting errors that can draw IRS attention:

“When it comes to 1099s, money made on stocks or interest can be forgotten pretty easily.” – Stephen Weisberg, Principal Attorney and Founder, The W Tax Group

Catching and correcting these mistakes as soon as possible is essential for reducing the risk of an audit.

Fixing Income Report Issues

To ensure your income reporting is accurate and to stay off the IRS’s radar, follow these steps:

• Track Income Regularly
  Use accounting software or a simple spreadsheet to monitor all income sources. Cross-check your records with tax documents to spot discrepancies early.
• Organize Tax Documents
  Gather all necessary tax forms before filing, such as W-2s and 1099s. If a form is missing, contact the issuer immediately to avoid filing incomplete information.
• Maintain Detailed Records
  Keep thorough documentation of all income streams, including sales receipts, deposit records, electronic payments, contractor payments, and investment transactions.

If you discover an error after filing, you can correct it by submitting Form 1040-X. This form must be filed within three years of the original return. For tax years 2021 and later, you can file it electronically, which speeds up the refund process.

The IRS’s automated systems match third-party data with your tax return. By keeping detailed and accurate records, you can ensure compliance and reduce the likelihood of an audit.

Trigger 2: Questionable Deductions

Deductions That Raise Eyebrows

The IRS often flags deductions that seem out of sync with a taxpayer’s income. Claims like excessive home office expenses, inflated vehicle costs, or unusually large charitable contributions without proper proof are common triggers for scrutiny. Financial expert Megan Gorman explains, “Anomalies, such as a substantial mortgage interest deduction following the surge in low-rate mortgages from 2020 to 2022, could draw unwanted attention”. The solution? Solid, organized documentation.

Keeping Deduction Records in Check

Good record-keeping is your best defense against IRS scrutiny. A recent U.S. Tax Court case serves as a cautionary tale: a $13,596 vehicle expense deduction was denied because the taxpayer relied on estimated mileage logs instead of actual, contemporaneous records.

Here are some practical tips to ensure your records can withstand an audit:

• Log Expenses as They Happen
  Write down details at the time of purchase. For business meals, include the names of attendees and the purpose of the meeting.
• Save All Supporting Documents
  Keep canceled checks with detailed payment information and original receipts. Credit card statements alone won’t cut it. Be sure to note the business purpose for travel and entertainment expenses.
• Be Precise with Vehicle Expenses
  Use actual odometer readings, not estimates. Record the purpose of each trip and maintain mileage logs as you go.

“Subsequently prepared mileage records do not have the same high degree of credibility as those made at or near the time the vehicle was used and supported by documentary evidence.” – U.S. Tax Court

For every deduction, make sure your records include the amount, date, location, business purpose, and any involved parties. Back it all up with proper documentation.

The IRS uses advanced systems to compare your deductions with those claimed by taxpayers in similar situations. Detailed records not only reduce the chance of an audit but also ensure you’re ready if one happens.

Trigger 3: Tax Credit Mistakes

Mistakes in claiming tax credits are a common reason for IRS audits. According to IRS data, about 25% of Earned Income Tax Credit (EITC) returns contain errors. This is part of the IRS’s broader approach to examining discrepancies in reported information.

Common Credit Problems

More than 60% of credit-related issues stem from three main errors:

Qualifying Child Confusion
Many taxpayers struggle to understand the rules for claiming dependents. To qualify, a child must meet all four of these criteria:

• Relationship: The child must have a specific relationship to the taxpayer.
• Age: The child must meet age requirements.
• Residency: The child must have lived with the taxpayer for more than half the year.
• Joint Return Restrictions: The child cannot file a joint return, except in limited cases.

Filing Status Errors
Errors occur when married taxpayers incorrectly select “single” or “head of household” as their filing status, which can raise red flags.

Income Reporting Issues
Accurate income reporting is critical, especially for income documented on:

• W-2 forms
• 1099-MISC
• 1099-NEC
• 1099-K

“I have seen [the child tax credit] denied for people who have filed before they got the Social Security number for a dependent. And there’s no going back.”

• Tom O’Saben, Enrolled Agent and Director of Tax Content and Government Relations at the National Association of Tax Professionals

Credit Qualification Rules

To avoid audit risks, it’s essential to follow strict qualification rules and ensure accurate documentation.

Documentation Requirements
Keep detailed records to prove your eligibility, including:

• Social Security numbers for all qualifying children
• Documents that verify the child’s residency and relationship to you

Verification Tools
Take advantage of IRS tools to confirm your eligibility before filing. Resources like the EITC Qualification Assistant, Interactive Tax Assistant, and Form 886-H-EIC Toolkit can help ensure accuracy.

“A lower-income family who doesn’t know how to claim the credit ‘misses out on thousands of dollars.'”

Trigger 4: Self-Employment Issues

If you’re self-employed and filing a Schedule C, you’re likely on the IRS’s radar. Understanding the common triggers for audits can help protect your business and keep things running smoothly.

Schedule C Red Flags

The IRS pays extra attention to certain areas on Schedule C that often lead to audits:

Excessive Deductions
Deductions that seem too high compared to your income or industry norms can raise eyebrows.

Recurring Business Losses
If your business consistently reports losses, it could signal potential issues like:

• Claiming personal expenses as business deductions
• Failing to report all income
• Treating a hobby as a business

Vehicle Usage Claims
Claiming 100% business use of a vehicle is a major red flag. Since most vehicles serve both personal and business purposes, you’ll need detailed mileage logs, fuel receipts, and other documentation to back up any such claim.

But Schedule C isn’t the only area to watch out for – cash-based businesses also face intense scrutiny.

Cash Business Records

If your business handles a lot of cash, meticulous recordkeeping is a must. The IRS keeps a close eye on cash transactions, so staying organized is key.

Required Documentation
Keep accurate records of every cash transaction. This includes receipts, invoices, and bank deposit slips. If you handle cash payments over $10,000, you’re required to file Form 8300.

Electronic Record Requirements
For businesses using digital systems, ensure your records include all transaction details, capture accurate data, and are stored in formats the IRS can easily access.

Trigger 5: Major Money Moves

When it comes to significant financial decisions, following IRS reporting rules is a must to avoid unwanted scrutiny. Large transactions, especially those involving foreign accounts or cryptocurrency, are often flagged by the IRS. Here’s what you need to know about these two areas.

Foreign Account Rules

If the total value of your foreign accounts exceeds $10,000 at any point during the year, you’re required to file a Report of Foreign Bank and Financial Accounts (FBAR). This report must be filed electronically through the BSA E-Filing System by April 15, although there’s an automatic extension to October 15. Importantly, you should keep all related records for at least five years from the filing date. Late filings may avoid penalties if submitted with reasonable cause.

To complete the FBAR, you’ll need to provide:

• Account names and numbers
• The names and addresses of foreign banks
• Types of accounts (e.g., savings, checking)
• The maximum value of each account during the year

Failing to file an FBAR when required can lead to severe consequences, including hefty fines and, in some cases, criminal charges.

Crypto Tax Rules

As cryptocurrency becomes more mainstream, the IRS has tightened its grip on digital asset transactions. Keeping up with these changes is essential. Brokers are now required to report gross proceeds using Form 1099-DA, which will be issued to taxpayers by February 16, 2026, and filed with the IRS by March 31, 2026. Additionally, exchanges must provide updated 1099 forms summarizing trading activity.

The IRS doesn’t just rely on voluntary reporting. They use tools like exchange data, blockchain analysis, and even direct questions on Form 1040 to track unreported crypto activity. For instance, in a high-profile case, the IRS issued a John Doe summons to Coinbase, demanding detailed information on around 13,000 accounts. This included personal details like names, taxpayer IDs, and transaction histories to identify unreported crypto income.

To stay on the right side of the IRS:

• Document all crypto transactions meticulously
• Report every taxable event accurately
• Use crypto tax software to simplify tracking
• Stay informed about the latest IRS rules

The IRS has ramped up its focus on crypto, especially with the surge in values seen in 2024. By establishing solid record-keeping habits now, you can reduce the chances of triggering an audit in the future.

Conclusion: Preventing IRS Audits

Avoiding an IRS audit comes down to understanding and addressing common triggers like income discrepancies, questionable deductions, and self-employment missteps. In fiscal year 2022, 3.8 out of every 1,000 tax returns were examined, making accurate documentation a crucial safeguard.

Tips to Steer Clear of Audits

Staying organized and planning ahead can significantly reduce your chances of being audited. Here are some practical steps to consider:

Stay on Top of Record-Keeping

• Keep detailed records of all income and expenses.
• Hold onto tax documents for at least three years, and employment-related records for four years.
• Organize receipts, invoices, and other financial paperwork in one accessible place.

Plan Your Taxes Wisely

• Strategically time income and expenses to optimize your tax liability.
• Adjust the timing of major expenses and charitable donations to better manage taxable income.
• Take full advantage of contributions to tax-deferred accounts like 401(k)s and IRAs.

“Mismatched data is the No. 1 thing that gets taxpayers into trouble. If you leave stuff off [your return], that could get a question.” – Mark Steber, chief tax information officer at Jackson Hewitt

These habits create a strong foundation for audit prevention. For more complex situations, seeking professional guidance can provide added protection.

When to Call in the Experts

While good recordkeeping and smart planning are essential, a tax professional can be invaluable for navigating complicated scenarios. They can help with intricate filings, ensure accurate income reporting, and even represent you during an audit.

“A certified public accountant, EA, or tax attorney can provide critical help navigating complex filing situations like foreign assets disclosures, alternative minimum tax exposure, self-employment leases, mergers and acquisitions, executive compensation, and many other intricate areas.” – Lewis CPA

Enlisting expert help isn’t just about staying compliant – it’s about securing your financial future.

If you feel that you’re in the “audit-zone” with your returns, feel free to give us a call and we’ll get you sorted in no time.

Welcome to the New Age of Accounting. Let’s being.

FAQs

What should I do if I discover a mistake in my income reporting after filing my tax return?

If you’ve discovered an error in your reported income after submitting your tax return, don’t worry – you can fix it by filing an amended return. To do this, you’ll need Form 1040-X, Amended U.S. Individual Income Tax Return.

Take the time to thoroughly review the instructions for Form 1040-X and include any necessary supporting documents, such as updated W-2s or 1099s. You can file the amended return electronically for recent tax years, or mail it to the IRS if required. Addressing the issue promptly can help reduce any penalties or interest that might apply to additional taxes owed.

What steps can I take to properly document my deductions and tax credits to reduce the risk of an IRS audit?

To reduce the chances of an IRS audit, make sure you maintain organized and accurate records of your deductions and tax credits. Keep supporting documents like receipts, invoices, and bank statements for at least three years. These should clearly show the amount, date, and purpose of each expense.

For business expenses, hold onto canceled checks, receipts, and invoices that include details like the payee, amount, and a description of the product or service. If the expense covers travel, meals, or entertainment, be sure to record the business purpose, the date, and the names of those involved. Staying on top of your documentation not only helps you substantiate your claims but also minimizes the likelihood of facing unnecessary IRS scrutiny.

What do I need to know about reporting cryptocurrency transactions to avoid IRS issues?

When preparing your federal income tax return, it’s essential to include all income from cryptocurrency activities. This means reporting income from sales, trades, or any other taxable events involving digital assets. You’ll also need to answer the specific question on your return about whether you participated in any cryptocurrency-related activities during the tax year.

To ensure you’re meeting IRS requirements, keep detailed records of every transaction. This includes noting the dates, amounts, and purposes of each activity. Having thorough documentation not only helps you file accurately but can also minimize the chances of facing IRS scrutiny.

Chris Landqvist

Chris is the Managing Partner at Weston Tax Associates, a best-selling author, and a renowned tax strategist. With over 20 years of expertise in tax and corporate finance, he simplifies complex tax concepts into actionable strategies that drive business growth. Originally from Sweden, he now lives in Florida with his wife and two sons.