what causes an irs audit
Updated July 25, 2023

What Causes an IRS Audit? (9 Possible Reasons)

Personal Taxes

The IRS received 164 million individual tax returns in 2022, most of which were processed without additional examination.

However, like every year, the IRS double-checked a certain percentage of tax returns, 0.38% to be exact, to ensure the information they received was accurate.

You might be wondering, what causes an IRS audit? And why do audits affect such a small percentage of the nation’s population?

As it turns out, most audits are triggered by easily avoidable mistakes rather than attempts to hide the income from the federal government.

Let’s take a closer look at what an IRS audit is and the most likely red flags that might put your tax return on the IRS’ radar.

What is an IRS Audit?

In layperson’s terms, an IRS audit is a tax return review conducted to determine if the submitted amount is calculated correctly.

The Discriminant Information Function system analyzes all tax returns and looks for anomalies or statistical aberrations that don’t match the taxpayer’s profile. The system usually scans tax returns for the previous fiscal year, but tax returns remain audit-eligible for three years.

So if you’re flagged for an audit, an agent or tax auditor will review your tax returns for the last two fiscal years. But, the IRS reserves the right to review returns for the last six years if the initial audit reveals considerable deviations from the system’s norm.

Most IRS audits are conducted via mail. However, in more complex cases, audits involve an in-person interview. The Inflation Reduction Act of 2022 has provided the IRS with the funding and resources it needs to audit high-income taxpayers.

Hence, the percentage of regular (interview-based) audits will likely increase in the coming years.

Audit Rates and Taxable Income

Statistics show that IRS audits mostly affect low-income taxpayers. For the same reason, in 2022, an estimated 300,000 lowest-wage earners with tax returns under $25,000 were audited.

Hence, taxpayers from this examination class were likelier to be audited than medium and high-wage earners. The reasons for this are manifold and usually have little to do with incorrectly filed taxes.

Hence, taxpayers from this examination class were likelier to be audited than medium and high-wage earners. The reasons for this are manifold and usually have little to do with incorrectly filed taxes.

Low-wage earners who claimed the Earned Income Tax Credit (EITC) receive more mail audits than other IRS examination classes.

The IRS maintains that audit rates don’t depend on taxable income, even though the numbers indicate that taxpayers who earn more than 1$ million per year have only a 1.1% chance of being audited by a revenue agent or tax auditor.

The Usual Causes for an IRS Audit

Being honest and providing all information about your income remains the best way to avoid a correspondence or face-to-face IRS audit.

Here are some of the most common reasons why the IRS audits tax returns.

1. Reporting Only a Portion of the Annual Income

The majority of your annual income is taxable. So, forgetting to include all your sources of revenue in a tax return is likely to trigger an audit.

The IRS receives copies of W2, K1, and 1099 forms and enters them into the DIF system that searches for discrepancies between the information in these forms and tax return forms.

Hence, the total and taxable income amounts have to be the same on all forms a taxpayer submits to the IRS.

2. Unusual Charity Donations

Donating a vast sum or a valuable item to charity might put you on the IRS’s radar, especially if that sum is disproportionate to your annual income.

You’ll have to appraise the item you’d like to donate, obtain a receipt and submit the 8283 form with the tax return for all items with an estimated value over $5,000 since failing to do so might trigger an IRS audit.

Moreover, trying to qualify for a charitable contribution tax deduction by reporting false donations can only get you in trouble.

3. Excessive Use of Self-Employment Tax Deductions

Freelancers and contractors are eligible for a wide array of tax deductions that compensate for their business expenses. If you’re self-employed, you can find the full list of tax deductions you’re eligible for in the Schedule C of form 1040.

Understanding that these tax deductions don’t apply to personal expenses is important. Once again, being honest and requesting tax deductions only for the actual costs you had to cover to keep your business running is the best way to avoid an IRS audit.

Tax Deductions for Freelancers

Mileage, travel, or entertainment tax deductions are among the perks of being a freelancer. However, you must carefully tread because claiming tax deductions that are above average for the field you’re working in probably won’t go unnoticed.

For instance, you shouldn’t claim that you spent a considerable portion of your pretax income on business travel if you don’t have the documentation to prove your claim. In addition, freelancers and contractors must report income for each job they complete during a fiscal year.

Home Office Deductions

The IRS has a clear set of guidelines for a home-based business. Form 8829 and Publication 587 stipulate who can deduct expenses for business use of a home and the circumstances under which businesses are eligible for home office tax deductions.

Generally speaking, the space must only be used for professional purposes to qualify for this type of tax deduction. So, your tax return might raise a red flag in the DIF system if you cannot prove that you use a part of your home as your principal place of business.

4. Returns with EITC

Filing taxes with the Earned Income Tax Credit increases your chances of triggering an IRS audit. However, most audits are conducted through mail and resolved fairly quickly.

So, you shouldn’t have anything to worry about as long as the information you submitted to the IRS is accurate.

5. Accepting Too Many Payments in Cash

Restaurants, barbershops, and all other cash businesses are likely to trigger an audit because the IRS wants to prevent their owners from hiding some of their income.

Failing to include tips in the tax return can also be a reason for an audit which is why you must provide detailed documentation if your business makes large cash transactions frequently.

Also, you must notify the IRS whenever you make a transaction over $10,000 and supply information regarding the money’s origin.

6. Failing to Distinguish Between a Business and a Hobby

Learning the distinction between a hobby and a business can save you the trouble of dealing with an audit.

The IRS views businesses that generate zero net profit in three out of five fiscal years as hobbies. In addition, it provides detailed instructions you can use to determine if an activity is a business or a hobby.

You’ll have to provide evidence to support the claim that the activity you’re engaging in is in fact a hobby when filing a tax return because you might trigger an IRS audit if you don’t.

7. Holding Foreign Financial Assets

Keeping money in a bank account in a foreign country can make the IRS suspicious.

The IRS has the right to request the list of all American citizens with accounts in a foreign bank and won’t hesitate to initiate an FBAR audit if it determines the account holder has more than $10.000 in a foreign account.

Providing incorrect information in the Foreign Bank Account Report will trigger a rigorous FBAR audit that can result in criminal charges. Participating in abusive tax schemes can also result in harsh penalties.

8. Omitting Investment Income in the Tax Report

IRS audits caused by failure to report investment income are usually resolved quickly. In most cases, the IRS informs taxpayers that dividends or interests they received during a fiscal year aren’t included in the tax return.

Afterward, a taxpayer can accept to pay the tax for the added income and avoid a full audit.

9. Bitcoin and NFT Transactions

The rise of Blockchain technology has generated billions of dollars of hidden income in the last few years. That’s why the IRS keeps a close eye on all digital transactions, especially those involving bitcoin and NFTs.

Form 1040 contains a question regarding digital asset transactions, and you’ll have to provide detailed information about each transaction if you answer affirmatively.

How to Avoid Triggering a Tax Audit

The chances of being audited are small if the information you provided in the tax return is accurate and matches the DIF system’s norms. Here are a few things you can do to avoid raising any red flags when filing tax returns:

  • Calculate the total and taxable income a few times and make sure each digit is correctly written
  • Keep a record of all your financial transactions
  • Pay taxes on time
  • File a tax return before the deadline
  • Consider hiring a tax advisor if you’re running a multifaceted business with several revenue sources to ensure your tax return won’t trigger an audit.

Frequently Asked Questions About IRS Audits

How Long Does an IRS Audit Last?

According to the Statute of Limitations, the IRS must conclude an audit within three years. The Internal Revenue Manual indicates that agents must close all investigations in 26 months, but most audits are completed within a year.

How Much Time Do I Have to Respond to an IRS Audit Letter?

You must respond to an IRS audit within 30 days from the moment you receive an IRS correspondence letter, a notice of audit meeting, or a CP2000 IRS letter. Still, you should gather all the required documentation before contacting the IRS.

How Many Types of IRS Audits Are There?

The most common types of IRS audits are correspondence audits, office audits, field audits, and taxpayer compliance measurement program audits.

Final Thoughts

The IRS doesn’t have the resources to review all tax returns it receives manually. Instead, its agents only review tax returns flagged by the DIF system and decide whether they should investigate.

Claiming tax deductions you’re not eligible for, failing to report all your sources of income, or trading with cryptocurrencies are some of the most common IRS audit triggers.

Hence, staying off the radar and avoiding an IRS audit is relatively easier since all you need to do is make sure your math is correct and you provide truthful information.


Logan Allec, CPA

Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.

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