How the IRS decides which returns to review

The IRS does not pick returns entirely at random. It uses automated scoring and information-matching systems to identify returns that deviate from expected norms or that conflict with third‑party reports. Systems such as the Discriminant Function System (DIF) and other analytics score returns for potential issues and inconsistencies; returns with high scores are more likely to be examined. The IRS explains its selection methods on its website and in taxpayer guidance (IRS — How the IRS Selects Returns for Examination: https://www.irs.gov/privacy-disclosure/how-the-irs-selects-returns-for-examination).

In practice, two forces increase audit likelihood:

  • Information matches: The IRS receives copies of W-2s, 1099s, and other third‑party information returns and compares them to what you report.
  • Anomalies vs. peers: Deductions or credits that are large relative to your income or industry averages will attract scrutiny.

I’ve worked with clients who thought audits were “random.” In reality, most audits start because something on the return didn’t line up with IRS records or statistical expectations.

Common red flags — what triggers an IRS audit (and how to avoid them)

Below are the most frequent triggers I see and concrete ways to reduce your risk.

  1. Unreported or mismatched income
  • Why it triggers an audit: The IRS receives copies of W-2s, 1099s, and broker statements and automatically compares those amounts to the income on your return. If amounts don’t match, you’ll likely get a notice.
  • How to avoid it: Reconcile all third‑party statements before filing. Review your IRS online account transcript to confirm reported wages and 1099 income. Report all income sources, including gig work, hobby sales, and investment proceeds.
  • Useful citation: IRS information‑matching procedures (https://www.irs.gov/privacy-disclosure/how-the-irs-selects-returns-for-examination).
  1. Large or unusual deductions for your income level
  • Why it triggers an audit: A Schedule A or Schedule C with deductions far above what is typical for someone with similar income or in the same industry will be flagged.
  • How to avoid it: Keep contemporaneous receipts, mileage logs, invoices, and a clear business purpose for each deduction. Use conservative estimates where substantiation is weak. If you claim a large charitable deduction, attach Form 8283 for noncash gifts over $500 and get appraisals when required.
  1. Self‑employment and Schedule C issues
  • Why it triggers an audit: Sole proprietors often claim many business expenses, losses, or the home office deduction—areas that require strong documentation.
  • How to avoid it: Separate personal and business finances with a dedicated business account and credit card. Maintain an organized accounting system and backup receipts. If you claim a home office deduction, document square footage, exclusive use, and a calculation (see Form 8829 guidance on the IRS site).
  • Internal resource: See our Small Business Audit Preparation Checklist for practical recordkeeping tips: Small Business Audit Preparation Checklist (https://finhelp.io/glossary/small-business-audit-preparation-checklist/).
  1. Repeated business losses or large losses that offset other income
  • Why it triggers an audit: Continuous losses can suggest a hobby rather than a business, or overstated expenses.
  • How to avoid it: Document profit‑making intent (business plan, advertising, time records, efforts to increase sales). Treat hobby income and expenses differently.
  1. Excessive charitable contribution claims
  • Why it triggers an audit: Very large charitable deductions relative to your income raise questions about valuation and substantiation.
  • How to avoid it: Keep donation receipts, written acknowledgements from charities, and appraisals for high‑value noncash gifts. Follow IRS substantiation rules and limits by AGI.
  1. Cash-heavy businesses and payments
  • Why it triggers an audit: Cash transactions are harder to track and historically have been associated with underreported income.
  • How to avoid it: Keep daily sales records, deposit slips, and reconciliations. Use point‑of‑sale systems that generate reports and preserve third‑party payment records.
  1. Cryptocurrency and foreign transactions
  • Why it triggers an audit: The IRS receives increasingly detailed information from exchanges and foreign account reporting. Failure to report crypto gains or foreign accounts results in strong penalties.
  • How to avoid it: Report virtual currency transactions accurately and keep exchange records, cost basis, and transfer history. If you hold foreign accounts, comply with FBAR/Form 8938 reporting rules.
  • Authoritative guidance: IRS virtual currency information (https://www.irs.gov/businesses/small-businesses-self-employed/virtual-currencies).
  1. Mathematical errors and claim mistakes
  • Why it triggers an audit: Math errors often create mismatches or incorrect credits. While some are corrected by the IRS without a full audit, they can trigger additional scrutiny.
  • How to avoid it: Use reputable tax software or a qualified preparer, and review returns for accuracy before filing.

Types of audits and what to expect

  • Correspondence audits: Conducted by mail; the IRS requests documentation for specific items. These are the most common and often the easiest to resolve.
  • Office audits (in‑person at an IRS office): Require you to bring records to the IRS for review.
  • Field audits: IRS conducts an on‑site review at your home, business, or accountant’s office. These are less common and usually reserved for complex issues.

For practical guidance on responding to mail notices, review our article Responding to an IRS Correspondence Audit Notice: https://finhelp.io/glossary/responding-to-an-irs-correspondence-audit-notice/. For expectations during in‑person examinations, see What to Expect in an IRS Field Audit: https://finhelp.io/glossary/what-to-expect-in-an-irs-field-audit-2/.

What to do if the IRS contacts you

  1. Read the notice carefully and note deadlines. The IRS will tell you what it needs and how long you have to respond.
  2. Gather documentation that directly supports the items under question (receipts, canceled checks, bank statements, invoices, contracts, logs).
  3. If you disagree, prepare a clear, concise explanation and supply corroborating evidence. Consider a professional review before sending documents.
  4. Representation: You may authorize a CPA, enrolled agent, or attorney to represent you. Don’t ignore the notice; no response can lead to assessments without your input.
  5. Appeals and dispute resolution: If you disagree with the auditor’s findings, you can appeal within the IRS Appeals Office or pursue other remedies. See IRS Appeals (https://www.irs.gov/appeals).

Recordkeeping — the single best protection

Good records make audits quick and far less costly. The IRS recommends keeping records for at least three years in many cases, six years for substantial omissions, and longer for matters involving property or fraud. See the IRS page on how long to keep records: https://www.irs.gov/filing/individuals/how-long-should-i-keep-records.

Records to keep regularly:

  • Income records: W-2s, 1099s, brokerage statements
  • Business expenses: Receipts, invoices, bank statements, credit‑card statements
  • Asset records: Purchase and sale documents, depreciation schedules
  • Charitable gifts: Written acknowledgements and appraisals
  • Mileage logs and calendars for business travel

Our guide on preparing an audit packet lists the documents auditors commonly request and how to organize them: Preparing an Audit Packet: What to Send to an IRS Auditor (https://finhelp.io/glossary/preparing-an-audit-packet-what-to-send-to-an-irs-auditor/).

Practical examples from my practice

  • Example 1: A self‑employed consultant claimed large home office and travel expenses without contemporaneous logs. The client reconstructed mileage and a dedicated home office measurement, then established a routine record system. The IRS closed the case after the client provided organized documentation.

  • Example 2: A taxpayer underreported 1099‑misc income due to a bookkeeping error. When matched to third‑party reports, the IRS issued a notice. The taxpayer promptly filed an amended return, paid tax plus interest, and avoided penalties by showing reasonable cause.

These cases show two themes: timely, honest responses and organized records reduce penalties and the time the IRS spends examining a return.

Quick audit‑risk reduction checklist

  • Reconcile all 1099s, W‑2s, and broker statements before filing.
  • Keep detailed receipts, logs, and contemporaneous documentation.
  • Separate business and personal accounts.
  • Use conservative estimates for ambiguous expenses, or obtain professional support.
  • Report crypto and foreign accounts correctly.
  • File amended returns promptly if you discover errors.

Limitations, deadlines, and common questions

  • Statute of limitations: Generally three years from the filing date for the IRS to examine a return. If you omit more than 25% of gross income, the period extends to six years; there is no statute of limitations for fraud or failing to file. See IRS guidance on recordkeeping and statute of limitations (https://www.irs.gov/filing/individuals/how-long-should-i-keep-records).
  • Appeals: Many disagreements can be resolved in the IRS Appeals Office without U.S. Tax Court litigation (https://www.irs.gov/appeals).

Final thoughts and next steps

An audit need not be a crisis. Most audits begin with an information mismatch or an item that stands out from statistical norms. The best defenses are accurate reporting, organized records, and prompt, professional responses when the IRS asks questions. If you want a practical starting point, run through a small business audit preparation checklist or prepare an audit packet in advance (links above).

Professional disclaimer: This article is educational only and not tax advice. For personalized guidance, consult a qualified tax professional, CPA, enrolled agent, or tax attorney familiar with your situation.

Sources and further reading

Related FinHelp guides

If you’d like, I can convert the quick checklist above into a one‑page printable audit readiness worksheet tailored to employees, contractors, or small business owners.