What Triggers an IRS Audit? Red Flags to Avoid

How the IRS selects returns for audit

The IRS uses a mix of automated systems, information matching, and manual review to select returns for further examination. Selection falls into three broad categories:

• Automated matching and information returns: The IRS compares income reported on a tax return to third-party documents (W-2s, 1099s) filed by employers, banks, and payers. Mismatches or missing income often trigger follow-up (IRS, matching programs).
• Computerized risk-scoring and filters: Historically known as the Discriminant Inventory Function (DIF), today’s systems score returns for anomalies by comparing a return’s line items to norms for similar taxpayers. Extremely high deductions relative to income, large charitable gifts, or inconsistent business expenses can push a return above normal risk thresholds (IRS, Audit Techniques Guides).
• Issue-based selection and leads: Certain credits (for example, the Earned Income Tax Credit) and industries with higher noncompliance get additional scrutiny. The IRS also opens audits from third-party leads, whistleblower tips, or issues found during compliance campaigns.

These selection methods mean audits are not always random — they’re often the result of detectable patterns or mismatches.

Sources: IRS information-matching programs; IRS Audit Techniques Guides (irs.gov).

Common red flags that raise audit risk

Below are the most frequent triggers tax professionals see when a return draws scrutiny:

1. Unreported or underreported income

• Missing wages, Form 1099 income, brokerage dividends or capital gains are the simplest and most common triggers. Employers, banks, and brokerage firms file information returns that the IRS matches to your return; omitted items typically produce automated notices or audits.

1. Large or disproportionate deductions

• Charitable donations, unreimbursed business expenses, or home office and vehicle deductions that are large relative to reported income attract attention. Deductions must be ordinary, necessary, and substantiated.

1. Excessive business losses for hobby versus business

• Repeated losses on a Schedule C without evidence of profit motive can trigger an examination to determine whether the activity is truly a business or a hobby (which has different deduction limits).

1. High cash transactions and cash businesses

• Restaurants, salons, construction, and other cash-heavy industries have a higher baseline of IRS scrutiny because cash makes underreporting easier.

1. Claiming refundable credits incorrectly

• Credits like the Earned Income Tax Credit (EITC) or certain refundable child-related credits are subject to filters that flag returns with questionable eligibility. The IRS runs additional checks on these claims.

1. Significant changes year to year

• Large swings in income, sudden charitable spikes, or new types of income (cryptocurrency, gig-work) compared with prior years can invite review.

1. Rounding and patterns that look fabricated

• Unusual rounding to whole thousands or repetitive patterns across many figures may appear artificial and trigger closer review.

1. Foreign accounts, assets, and filings

• Failure to report foreign bank accounts (FBAR) or required disclosures (Form 8938) is a known trigger; the IRS coordinates with other agencies and has compliance programs targeting offshore accounts.

1. Large business deductions that don’t match industry norms

• If your business expenses are far above typical for your NAICS or occupation, the return can be flagged. The IRS has industry profiles it uses to benchmark activity (IRS Audit Techniques Guides).

1. Inadequate documentation for large claims

• The lack of receipts, cancelled checks, or contemporaneous records for big deductions is a practical red flag because it makes defense during an audit difficult.

Real-world examples and common pitfalls

• Example 1: A freelance graphic designer reported $60,000 in 1099 income but only reported $30,000 on Form 1040 because they believed only amounts actually deposited into their bank needed reporting. The IRS’s information return matching spotted the difference and led to a correspondence audit.

• Example 2: A taxpayer claimed $75,000 in charitable deductions on a $90,000 return with no acknowledgment letters or canceled checks. The size of the shelter triggered an in-person audit and ultimately a disallowance for undocumented gifts.

These are representative of common oversight — not malfeasance — but the outcome is the same: a heightened chance of adjustments, penalties, or interest.

How to reduce your audit risk (practical, professional tips)

In my 15 years working with individual and small-business taxpayers, these procedures reduce both the likelihood and the stress of an audit:

• Report everything. Reconcile your Forms W-2, 1099, and brokerage statements with your return before filing. The IRS matches those forms against filed returns.
• Keep contemporaneous records. For business expenses and charitable gifts, maintain receipts, bank records, mileage logs, and written explanations of business purpose. For donations over $250, get the written acknowledgment the IRS requires.
• Be reasonable and consistent. If you suddenly double your deductions without underlying business growth, expect questions. Document the reason for sudden changes in income or expenses in your records.
• Use safe-harbor rules when available. For example, the IRS offers simplified home-office and mileage rules; follow them consistently and keep the backup records.
• Hire competent help for complex issues. Payroll, retirement plan contributions, international transactions, and large asset sales often benefit from professional preparation and review.
• File accurate returns and respond promptly to IRS notices. Ignoring correspondence increases penalties and limits resolution options.

Related guides from FinHelp:

• Preparing for a Tax Audit: Documents, Timeline, and Tips
• How the IRS Calculates Your Audit Risk Score

What happens when the IRS contacts you

The IRS generally begins with a letter or notice asking for clarification or additional documents (a correspondence audit). Depending on the issue, the IRS may escalate to an in-person office audit or a field audit at your business or home. Typical steps:

1. Initial notice or CP letter describing the issue and requesting documentation.
2. You respond with supporting records or an explanation; a tax professional can prepare a response packet (see FinHelp guide on document packets).
3. If unresolved, the case may result in adjustments, a proposed bill, penalties, or an in-person examination.
4. You have appeal rights and can request an Office of Appeals review if you disagree.

See FinHelp’s practical checklists for preparing for correspondence and field audits: Preparing a Document Packet for an IRS Correspondence Audit and Preparing for an IRS Field Audit: Checklist.

Documentation: what to keep and for how long

• Keep tax returns and supporting documentation for at least three years from the date you filed, or two years from the date you paid the tax — whichever is later. The IRS can go back further in certain cases (e.g., substantial understatement of income).
• For property and assets, keep records for the period you own the property plus three years after sale.
• For employment taxes, retain records for at least four years after the tax becomes due or is paid.

Good recordkeeping is your best protection. The Taxpayer Advocate Service and IRS guidance underscore that clear, organized documentation frequently resolves issues without penalties.

If you are audited: best practices

• Stay calm and respond on time. Read the notice carefully and provide the requested documents in the format asked.
• Provide organized documentation with a clear explanation and cross-reference items to specific tax return lines.
• Consider professional representation. Enrolled agents, CPAs, and tax attorneys can represent you before the IRS. If the case is complex, early representation helps preserve rights and shape negotiation.
• Understand your appeal rights. You may be able to appeal proposed adjustments to the IRS Office of Appeals before paying disputed amounts.

Common misconceptions

• “Only high earners get audited.” False — audits occur across income levels. The selection process targets anomalies, not income alone.
• “If I don’t open the IRS letter it will go away.” False — ignoring notices often leads to increased penalties, enforced collections, or loss of appeal options.
• “A correspondence audit is always minor.” Not necessarily — a correspondence audit can lead to further field audits if the IRS remains unconvinced.

Final checklist to avoid audit triggers

• Reconcile all third-party statements and forms before filing.
• Substantiate all significant deductions with contemporaneous records.
• Use reasonable estimates and standardized methods (e.g., for mileage).
• File and respond on time.
• Ask for professional help when returns include international issues, significant asset sales, or complex business transactions.

Professional disclaimer: This article is educational and does not replace individualized tax advice. For specific guidance tailored to your circumstances, consult a licensed CPA, enrolled agent, or tax attorney. IRS guidance referenced in this article is available at the IRS website (irs.gov) and related Audit Techniques Guides.

Authoritative sources and further reading

• IRS — Audit Techniques Guides and information on examinations: https://www.irs.gov/ (search for “Audit Techniques Guide”)
• IRS — Earned Income Tax Credit (EITC) information: https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit-eitc
• Taxpayer Advocate Service: https://taxpayeradvocate.irs.gov/

In my practice, careful documentation and timely responses are the two habits that most often prevent small issues from becoming contentious audits. Follow the recordkeeping and reporting tips above to keep your returns defensible and to reduce the chance the IRS will select you for examination.