IRS audits are a concern for many Americans, with high-net-worth individuals often facing even greater scrutiny from the IRS. Many taxpayers also think the IRS can only audit tax returns for three years, but important exceptions can extend the audit window, sometimes indefinitely. Below, we’ll look at what an audit entails, how far back the IRS can audit you, and common reasons why Americans are getting audited. Although no one is completely immune from an IRS examination, understanding the audit process and common triggers can help you avoid surprises and be prepared by keeping the right records.
What is an IRS Audit?
An IRS audit is a meticulous review of financial records and tax filings to ensure compliance with current tax laws and regulations, including reported income, deductions, and credits. Depending on the size and scale of your tax return, the length of an audit can vary from a few short weeks or even months long.
How Far Back Can the IRS Audit You?
Generally, the IRS adheres to a three-year statute of limitations for tax audits. This means that they can review your tax returns for the three years preceding the current tax year. However, certain circumstances can extend this period to six years, usually if there is a substantial underreporting of income. In cases of fraud or failure to file a return, there is no time limit.
The date the statute of limitations begins depends on when you filed your tax return. If you filed your return before the due date, the IRS has three years from the due date to audit your return. If you filed late — after April 15 (Tax Day) — without an extension, the IRS has three years from the date you filed to audit you. Lastly, if you filed with an extension, the IRS has three years from the extended due date.
If you amended your tax return, the audit clock doesn’t get extended, but if you filed close to the end of the three-year deadline, the IRS may take 60 more days to audit your return.
When the IRS Has Longer to Audit
In some cases, the IRS has six years to audit you. This can happen when more than 25% of gross income is left out of the return or when a taxpayer substantially overstates the basis of property sold.
Other instances in which the IRS has six years to do an audit include if you fail to report foreign income over $5,000 or if you fail to report foreign gifts and inheritances. If you have ownership interests in foreign corporations, you may be required to file Form 5471. If you don’t, that can trigger penalties, and the IRS can audit your tax return indefinitely until you file the form.
Another example happens if you are required to file Form 8938, which is for specified foreign financial assets. If you fail to do so, the IRS doesn’t have a time limit to audit you.
If you never filed a tax return, the IRS can audit you for that tax year at any time, and if the IRS believes you committed civil fraud, the statute of limitations continues indefinitely. Criminal tax fraud cases are generally subject to a six-year limitations period.
Once you’ve been audited, the IRS generally has 10 years to enforce or collect additional taxes and fees from you.
Who Gets Audited by the IRS the Most?
The overall odds of an IRS audit are low, about 4 out of every 1,000 returns. However, high-net-worth individuals are more likely to be targeted due to complex income sources, large deductions, and sophisticated financial structures. Self-employed people and those claiming the Earned Income Tax Credit (EITC) are also statistically more prone to facing IRS scrutiny.
What Are IRS Audit Triggers?
IRS audit triggers are specific events or patterns that may prompt the IRS to conduct a closer examination of your tax return. Recognizing these triggers is crucial for individuals and businesses that want to avoid unnecessary scrutiny. However, some audits are done on a random basis, so even if you have no common triggers on your return, you still could be subject to an audit (even though the chances are lower).
10 IRS Audit Triggers
Below are 10 of the most common triggers for IRS audits. Keep in mind, this isn’t the end of the list — there are many other potential audit triggers depending on a taxpayer’s particular situation.
- Large charitable donations
The IRS can reference data providing average charitable deductions based on various income levels. If you’re above average for your category, you might call attention to yourself. This is especially true if you’ve deducted charitable gifts of appreciated property. To avoid this red flag, make sure your donations are all properly substantiated, including by independent appraisals if required.
- Gambling losses
Generally, you can deduct losses up to the amount of your winnings on your personal return, but you must have proof to back up your claims. If your gambling activities rise to the level of professional gambler, you might be able to deduct a loss from other income, but the IRS often contests this tax treatment.
- Unreported income
It’s easy to miss income that might fall through the cracks, such as interest and dividends as well as non-employee compensation from Form 1099-NEC. If you fail to report the income, the IRS may uncover a discrepancy with the forms it receives. Be sure to give your tax professional all forms you receive.
- Rental income and deductions
You don’t want the IRS to find that you played fast and loose with the rules for rental properties. Showing a loss for the year despite a high rental rate or charging below-market rent could trigger an inquiry. Generally, you may use up to $25,000 of loss to offset income from non-passive activities, but you must meet specific participation requirements. Check with your tax advisor to see if you’re on firm ground.
- Home office deductions
If you regularly and exclusively use a portion of your home for your business, you may be able to deduct the expenses and depreciation associated with the space. Usually, the greater the business percentage claimed for use of the home, the greater the audit risk. Employees who work from home (as opposed to self-employed people) currently can’t claim a home office deduction. Now that more people are working from home, the IRS may look for taxpayers trying to bend the rules.
- Casualty losses
Despite recent legislative changes restricting casualty loss deductions, you can still write off losses to personal property sustained in a federally designated disaster area. But be aware that the IRS may scrutinize appraisals to determine if you’re inflating a disaster-area loss.
- Business vehicle expenses
The IRS often flags tax returns with large deductions for business vehicles, especially if they reflect double-digit depreciation allowances. Put simply, you’re required to keep a contemporaneous log of your driving activities, along with proper substantiation. To withstand any challenges from the IRS, keep a detailed record of your deductions or use an app like MileIQ or TripLog to automatically track your mileage and simplify your reporting.
- Cryptocurrency transactions
Cryptocurrency is still a relatively new potential audit target. The IRS now specifically asks on your return if you’ve bought or sold cryptocurrency. If you’ve answered yes, be prepared to substantiate the transaction information.
- Day trading activities
Most taxpayers offset capital gains and losses from securities sales on Schedule D of their personal tax returns. But claiming to be a “day trader” may help you benefit from favorable tax provisions, including deductions for specific expenses. If you do this, consult with your tax advisor to ensure you’re ready to respond to any IRS inquiries.
- Foreign income and bank accounts
Checking the box on Schedule B that indicates you have a foreign bank account could increase your chances of an audit. Conversely, failing to check the box when you should do so may also trigger an audit. The IRS matches up information it receives on foreign bank accounts. Generally, a taxpayer must file a Report of Foreign Bank and Financial Accounts (FBAR) if the aggregate value of assets in foreign bank accounts exceeded $10,000 during the prior year.
Best Practices for Going Through an IRS Audit
If you’ve received an IRS audit letter, keep in mind that you can navigate the process more easily if you take the following steps:
- Keep detailed records: Maintain documentation that supports your tax positions and basis.
- Report all income accurately: Complete reporting can help you avoid penalties.
- Consult a qualified tax advisor: An experienced CPA can provide tax audit support.
- Respond promptly to IRS notices: Timely action can keep the audit from expanding or leading to additional penalties.
- Conduct periodic tax reviews: Identify and address potential issues before they lead to an audit.
Of course, with proper tax reporting and professional help, you can reduce the likelihood of triggering an audit. The most important thing for taxpayers to do is keep relevant and easy-to-access records of their financial history going back at least three years. Although you may be able to stand up to the scrutiny, it’s wise to seek IRS audit support from an experienced accounting team, who can provide invaluable guidance with both IRS audit representation and prevention.
IRS Audit FAQs
Can the IRS Audit Me After Three Years?
In some cases, yes. Examples include when you underreport gross income by more than 25%, if the IRS suspects fraud, or if you failed to file certain forms when you have foreign interests, assets, or income. If you never filed a tax return, the IRS can audit you for that tax year at any time, and if the IRS believes you committed civil fraud, the statute of limitations continues indefinitely. Criminal tax fraud cases are generally subject to a six-year limitations period.
How Much Money Will the IRS Audit Me For?
The IRS doesn’t conduct audits expecting to receive a specific dollar amount or based on specific tax brackets. Sometimes taxpayers are selected for an audit based on random selection or comparison to similar returns, but there are also many potential audit triggers, like significant changes in deductions and credits or issues related to transactions with other taxpayers. In general, those with very low or no income and the ultra-wealthy have a higher risk of audits.
How Long Should I Keep Tax Records?
In general, you should keep at least three years of records. The IRS recommends keeping records for as long as the statute of limitations would have been. For example, if you think you could be audited because the IRS believes you underreported gross income by more than 25%, you may choose to keep records for at least six years.
Does Amending Taxes Trigger Audit?
Amending a tax return on its own does not trigger an audit, but if you made major changes to your income, deductions, credits, or dependents, that could raise suspicion. The IRS notes that amended returns go through a screening process and may be selected for audit.
What Happens During an IRS Audit?
The IRS handles audits by mail or during an in-person interview where your records are reviewed. According to the IRS, the interview may be at an IRS office, known as an office audit, or at the taxpayer's home, place of business, or accountant's/representative’s office, which is called a field audit. The first contact for an audit happens via mail.
A mail audit will ask for additional information or documents about your tax return. You may ask request an in-person audit. The IRS has Audit Techniques Guides that you can use to give you an idea of the audit process.
This content is for general informational purposes only and does not constitute tax, legal, or professional advice. Readers should consult their tax advisor regarding their specific situation before making any tax-related decisions.