Introduction
Even carefully prepared returns can attract IRS attention. The agency uses a mix of automated matching, statistical scoring, and manual review to decide which returns to examine (see IRS audit overview: https://www.irs.gov/audits). In my 15+ years of advising taxpayers, I’ve helped clients respond to audits prompted by seemingly small or surprising issues. Understanding common red flags and the documentation that neutralizes them is the best defense.
How the IRS typically selects returns
- Third‑party data matching: Employers and financial institutions send W‑2s and 1099s to both you and the IRS. If the numbers don’t match, the IRS receives an automatic discrepancy that may trigger a notice or audit.
- Statistical scoring and rules: The IRS uses algorithms and scoring models (historically referenced as DIF and related systems) to flag returns that deviate from norms for similar taxpayers.
- Information returns and referrals: Tip lines, whistleblower referrals, or other agency matches can also prompt audits.
For a plain‑language primer, see the IRS audits page (https://www.irs.gov/audits) and the IRS guide to understanding audits (https://www.irs.gov/individuals/understanding-audits).
The 12 unexpected red flags and how to address them
1) Large year‑to‑year income fluctuations
Why it flags: Sudden spikes or steep drops in reported income can look like unreported income, omitted wages, or calculation errors.
What to do: Keep records that explain the change—settlement agreements, sale documents, business startup paperwork, or Form 1099s. If you sold assets, keep the closing statements and basis documentation.
2) Disproportionate charitable deductions
Why it flags: High charitable gifts compared to your income can stand out on an automated review.
What to do: Keep donation receipts, written acknowledgments from charities (required for gifts of $250+), appraisals for noncash gifts over certain thresholds, and Form 8283 if applicable. See IRS guidance on charitable contributions.
3) Repeated business losses
Why it flags: Losses year after year may signal a hobby rather than a bona fide business, which affects allowable deductions.
What to do: Document steps taken to make the business profitable—advertising, business plans, profit projections, and evidence of commercial activity. The IRS examines factors in Publication 535 and hobby‑loss rules under Section 183.
4) Excessive itemized deductions relative to peers
Why it flags: If your itemized deductions are unusually large for your income bracket, automated checks may trigger closer review.
What to do: Keep receipts, canceled checks, and bank records supporting each deduction. For mortgage interest, retain Form 1098 and settlement statements.
5) Missing or unreported income (side gigs, freelancing)
Why it flags: Form 1099s and W‑2s sent to the IRS that don’t match taxpayer returns are among the most common triggers.
What to do: Reconcile all 1099s and W‑2s before filing. Use bank records and invoices to show earned income and pay estimated taxes for self‑employment income. If you receive a notice, respond quickly and provide supporting documents.
6) Inconsistent information across forms
Why it flags: Mismatched names, Social Security numbers for dependents, or inconsistent addresses can prompt inquiries.
What to do: Verify all personal information before filing. If an error gets through, correct it promptly using amended returns (Form 1040‑X) or by replying to IRS correspondence with documentation.
7) Large or frequent cash transactions
Why it flags: Because cash transactions can be harder to trace, the IRS may pay closer attention to returns reporting significant cash receipts or cash‑heavy businesses.
What to do: Maintain contemporaneous receipts, deposit slips, and invoices. For businesses, use cash‑register summaries and bank deposit records. If you receive a Form 8300 related to a single cash transaction over $10,000, retain the related documentation.
8) Significant rental losses or unusually high expenses on rental activities
Why it flags: The IRS tests whether rental activity is a real investment or personal use; excessive losses may invite an examination.
What to do: Keep lease agreements, expense receipts, proof of advertising, maintenance logs, and bank statements. If you claim depreciation, retain prior cost records and depreciation schedules.
9) Using round numbers for income and expenses
Why it flags: Repeated round numbers (e.g., $2,000, $5,000) can suggest estimates rather than actual records.
What to do: Use actual receipts and invoices. If you relied on reasonable estimates, keep the worksheets, logs, and methodology showing how you calculated totals.
10) Prior audit history
Why it flags: A previous audit can place you on the IRS’s radar for similar issues in future years.
What to do: Adopt stronger documentation practices after an audit. Keep the audit file and correspondence to demonstrate earlier compliance and any changes made.
11) Dependent information or SSN mismatches
Why it flags: The IRS matches dependent Social Security numbers and names; mismatches trigger verification requests.
What to do: Ensure dependents’ SSNs are correct on your return. If the IRS sends a CP05 or related notice, return the requested proof—birth certificates, adoption papers, or Social Security cards.
12) High‑income earners and complex returns
Why it flags: Higher incomes and complex transactions (partnerships, Schedule C businesses, large capital gains) naturally increase audit exposure because they offer more pathways for misreporting.
What to do: Work with a CPA or tax attorney for complex filings and maintain thorough documentation for transactions like asset sales, stock options, and business allocations.
Practical examples from my practice
- A taxpayer claimed unusually large medical expenses one year. We assembled receipts, EOBs (explanation of benefits), and insurance statements to show the outlays were legitimate; the audit closed without adjustment.
- A small business owner had five consecutive years of losses. We documented marketing plans, business registrations, and client contracts to show intent to profit, which helped rebut a hobby‑loss concern.
How to respond if the IRS contacts you
1) Read the notice carefully: The majority of IRS contacts start with a notice, not a surprise in‑person visit.
2) Do not ignore deadlines: Notices include response deadlines. Missing them can escalate the issue.
3) Gather documentation: Match the IRS’s questions to supporting records—bank statements, 1099s, receipts, contracts.
4) Consider professional help: If the audit involves complex issues or large amounts, hire a CPA, EA, or tax attorney. In my experience, experienced representation reduces error and stress.
What records to keep and for how long
- Generally keep tax returns and supporting records for three years from the date you filed, but keep records for six years if you underreport gross income by more than 25% and indefinitely for assets until you’ve recovered the asset’s tax basis through depreciation or sale. See IRS Publication 583 (Records) for specifics.
Common misconceptions
- Myth: Only underreporting income triggers audits. Fact: Overstated deductions, mismatched information, and odd patterns also trigger reviews.
- Myth: An audit always means fraud. Fact: Many audits are document reviews or math error checks—most resolve with clarification or minor adjustments.
Preventive checklist
- Reconcile all third‑party forms (W‑2/1099) and correct mistakes before filing.
- Maintain receipts, canceled checks, and electronic backups for all income and large deductions.
- Avoid rounded totals; use accurate figures supported by records.
- Keep a contemporaneous mileage log for business or medical travel (don’t reconstruct it months later).
- Consult a tax pro for complex transactions.
Internal resources
- For guidance on documenting a home office deduction, see our in‑depth home office deduction guide (finhelp.io/taxes/home-office-deduction).
- If you want best practices for recordkeeping, our tax recordkeeping checklist details what to save and how long to keep it (finhelp.io/taxes/recordkeeping-for-taxes).
- Self‑employed taxpayers should review our primer on self‑employment taxes and estimated tax payments to reduce missing‑income flags (finhelp.io/taxes/self-employment-taxes).
Final thoughts and professional disclaimer
Audits are stressful but usually manageable with prompt, organized responses. In my practice, proactive documentation and careful reconciliation of third‑party forms prevent most audit headaches. This article is educational and reflects professional experience; it is not a substitute for personalized advice. For specific audit responses or complex tax issues, consult a licensed tax professional (CPA, EA, or tax attorney) and refer to official IRS guidance (https://www.irs.gov/audits).
Authoritative sources
- IRS: Audits (https://www.irs.gov/audits)
- IRS: Understanding Audits (https://www.irs.gov/individuals/understanding-audits)
- IRS: Publication 583, Recordkeeping (https://www.irs.gov/pub/irs-pdf/p583.pdf)
- NerdWallet: IRS audit red flags (https://www.nerdwallet.com/article/taxes/irs-audit-red-flags)
- Forbes Advisor: Common IRS audit triggers (https://www.forbes.com/advisor/taxes/irs-audit-red-flags/)
