Matter & Substance
  April 18, 2024

Understanding IRS Audits: What to Expect

Although many American taxpayers may worry about being subject to an IRS audit, they’re often unsure about why an account gets flagged. Below, we’ll take a look at what an audit entails as well as common reasons why Americans are getting audited. Although you can never avoid audits completely, a comprehensive understanding may taxpayers better understand compliance and be prepared in the case they are selected for audit.

What Is an IRS Audit?

An IRS audit is a meticulous examination of financial information to ascertain compliance with current tax laws and regulations, including your reported income, deductions, and credits. Depending on the size and scale of your return, the length of an audit can vary from quick 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, primarily if there is a substantial underreporting of income. In cases of fraud or failure to file a return, there is no time limit.

Who Gets Audited by the IRS the Most?

The likelihood of getting audited is around 4 out of every 1000 returns, with certain people being targeted more frequently than others. Demographic trends play a role in determining who is more likely to undergo an IRS audit. Individuals with high incomes, the self-employed, and those claiming the Earned Income Tax Credit (EITC) are statistically more prone to facing IRS scrutiny. In fact, in 2021, low-income wage-earners were five and a half times more likely to be audited than anyone else.

What Are IRS Audit Triggers?

IRS audit triggers serve as 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 aiming to avoid unnecessary scrutiny. However, some audits are even 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 ten 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.

  1. 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.

  2. 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.

  3. 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 provide your tax professional with all forms you receive.

  4. 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 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.

  5. Home Office Deductions

    If you use a portion of your home regularly and exclusively 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.

  6. 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.

  7. Business Vehicle Expenses

    The IRS often flags returns with large deductions for business vehicles, especially if they reflect double-digit depreciation allowances. Briefly stated, you’re required to keep a contemporaneous log of your driving activities, along with proper substantiation. To withstand any challenges from the IRS, keep close record of your deductions.

  8. 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.

  9. 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.

  10. Foreign 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.


IRS Audit Process: What Happens If the IRS Audits You?

Of course, With proper tax reporting and professional help, you can reduce the likelihood oftriggering an audit. And if you still end up being subject to one, properdocumentation can help you withstand it with little or no negative consequences.

Who Can Help with an IRS Audit?

Navigating an IRS audit can be complex and daunting, but the most important thing for taxpayers to do is keep relevant and easy-to-access records of their financial history for at least three years back. Although taxpayers may be able to stand up to the scrutiny, seeking the assistance of an experienced accounting firm is advisable. Accounting firms can provide invaluable support with both IRS audit representation and prevention.

Contact Mowery & Schoenfeld for IRS Audit Representation

If you find yourself facing an IRS audit or wish to proactively safeguard against potential audits, don't hesitate to contact Mowery & Schoenfeld today. Our dedicated team is ready to provide expert IRS audit representation and comprehensive tax solutions.

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