IRS Red Flags For Audit

Terry Selb

April 28, 2023


While tax returns are generally reviewed and audited by human revenue agents, the IRS red flags also use a computer system to automatically flag returns that may have the potential to be audited. The computer then compares each return with similar income returns, assigning a numeric score. Higher scores mean that the return is more likely to trigger an audit.

High Income

High income can attract IRS scrutiny, particularly for a taxpayer who lives in a neighborhood or is in a similar industry to others who file their taxes in that area. For example, the IRS would likely be suspicious if a plumber makes hundreds of thousands of dollars and a CEO pulls in just over minimum wage.

Another factor that can increase the chance of a tax audit is excessive expenses. In addition to this, excessive use of your home can also raise a red flag. This is especially true if the portion of your house used as a business is disproportionately larger than other areas.

Another key indicator of a potential audit is the amount of foreign financial assets an individual holds. If you have significant foreign accounts and do not report them on your tax return, the IRS can find out about them through the Foreign Bank Account Report (FBAR). The more foreign assets you hold, the higher the risk of an audit.

Excessive Expenses

Even though IRS audits are a relatively small percentage of tax returns filed, some red flags might signal an audit is coming. Knowing those red flags can make you more prepared if an IRS examiner calls. Excessive expenses are a common audit trigger. For example, overvaluing home office expenses or donated goods may indicate poor accounting practices.

Another prime audit trigger is claiming 100% business use of your vehicle, especially if you don’t have other vehicles available for personal use. Keeping detailed mileage logs and precise calendar entries for every road trip can help you avoid an audit.

Claiming a home office deduction can increase your chances of being audited, but only those expenses that directly apply to the part of your house used as an office should be claimed. Failing to check the box on Schedule B indicating you have a foreign bank account can also trigger an audit.

The IRS inspection will also give a closer look at excessive business travel. The agency uses occupational codes to measure typical amounts of travel by profession, so a tax return showing 20% or more above the average might get a second look.

Disparate Charitable Deductions

The IRS is particularly interested in charitable deductions that exceed the average donations of people at a similar income level. This is because donating more than the average can suggest that you have a poor grasp of your income level, which raises the risk that you may understate your taxes somehow.

Similarly, outsized cash donations are also a red flag. Keep detailed records of all your business transactions, including those involving cash. Another issue that the IRS looks into is outsized non-cash contributions, such as artwork. The IRS can challenge these if they have been given without the proper substantiation requirements.

One way to avoid these issues is to donate money upfront to a donor-advised fund, which allows you to claim a tax deduction for that year while keeping the money in a fund until you want to distribute it.

Alternatively, you can convert your charitable deduction into a refundable credit. This would benefit taxpayers at all income levels and would increase the amount of charitable giving.

Excessive Use of Your Home

The IRS has a long history of looking closely at your tax returns. The agency aims to spot taxpayers that haven’t been paying their taxes on time or whose tax returns aren’t complete. In addition, it will take a closer look at your business and investment activities.

Keep accurate records of all contributions and tax deductions to stave off an IRS inspection. Take advantage of the Earned Income Tax Credit (EITC), the Credit for Work-Related Moving Expenses (CRME), and the Small Business Health Care Tax Credit (SBHCTC), among other tax credits and perks. Working from home, either full- or part-time, is one option. You may use the IRS’s online tool to learn more about what kind of job and schedule might suit you best.