5 IRS Audit Red Flags

As tax season approaches, many questions might race through your mind: Have I reported all my income? Are my deductions legitimate? Do I have the necessary documentation in case of an audit?

Even if you’ve done everything right, the thought of an IRS audit can make anyone sweat. The truth is, you could still be selected for additional scrutiny, even when your tax returns are in order. An audit can be triggered by factors outside your control—such as a business partner or investor getting audited. In some cases, IRS audits are random, but there are triggers that could increase your chances.

Here are five common IRS audit triggers that you should be aware of:

1. High Income

While earning a high income is a good thing, it also increases the likelihood of an IRS audit. According to the IRS 2014 Data Book, the higher your Adjusted Gross Income (AGI), the more likely you are to be audited. For example:

• Only 0.53% of taxpayers with an AGI between $50,000 and $75,000 were audited.
• This percentage jumps to 1.75% for those with an AGI between $200,000 and $500,000.
• If you earn over $10 million, your chances of being audited increase significantly to 16.22%.

The IRS tends to focus on higher-income individuals because the potential for tax discrepancies is greater.

2. Underreported Self-Employment Income

Self-employed individuals are also at a higher risk of an IRS audit, particularly if they underreport income or claim excessive deductions. If you file a Schedule C (Profit or Loss from Business), be cautious—this form is often scrutinized by the IRS. Some self-employed individuals may be tempted to blur the lines between business expenses and personal expenses, or even treat a hobby as a business.

In 2014, 5.26% of taxpayers with zero or negative AGI were audited—significantly higher than those with positive income. The IRS knows that some people either underreport their income or overstate their deductions, which makes them a prime target for an audit.

Consider investing in an Audit Protection Plan (APP) to safeguard yourself from the stress of an audit. Schedule a call to learn more about how we can help protect your business.

3. Excessive Deductions

Claiming large deductions can also raise red flags with the IRS. Common areas where taxpayers often overstate deductions include charitable donations and medical expenses. While it’s important to take the deductions you’re entitled to, you need to keep detailed records to support them.

If you’ve had a year with significant charitable contributions or unusually high medical expenses, be sure to maintain pristine documentation. The IRS will likely take a closer look if your deductions seem disproportionately high compared to your income.

4. Underreported Taxable Income

The IRS receives copies of all forms reporting your income, such as 1099s and W-2s. If you fail to report this income on your tax return, it could trigger an audit.

Be diligent in keeping track of all income forms that arrive in the mail during tax season. Starting a folder specifically for these documents will help ensure nothing slips through the cracks.

5. Early Retirement Distributions

If you withdraw from your 401(k) or IRA before age 59 ½, you’re typically subject to a 10% early withdrawal penalty. Failing to report these distributions—or not paying the associated penalties—can increase your chances of being audited.

In certain cases, the IRS may grant an exception to this penalty, but if you don’t qualify for one, it’s critical to report the withdrawal and pay the tax.

Take Steps to Minimize Your Audit Risk

While you can’t guarantee that you’ll never be audited by the IRS, being mindful of these common audit triggers can help reduce your risk. Proper documentation and accurate reporting are key to staying compliant and avoiding the stress of an audit.

For peace of mind, ensure that your financial records are thorough and accurate, and consult with a trusted professional to help navigate any complex tax situations. Proactive preparation is the best way to minimize the chances of facing an IRS audit.

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