30 Ways Your Tax Return Could Trigger an IRS Audit

For most taxpayers, it's unlikely that they will be audited by the IRS. But that doesn't mean it's completely out of the question. While the number of audits has dropped dramatically in recent years, the IRS knows that every $1 spent on audits brings in $4 to the Treasury Department. We spoke to several tax experts and found out just what the IRS is looking for when it's considering an audit and how you can trigger an audit through mistakes, oversights, and not-so-brilliant deductions. 

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The IRS freely admits that it needs only a single anomaly to audit a return. Sometimes, audits are based solely on a statistical formula that your return had the misfortune of deviating from. The IRS develops those "norms" from audits of a statistically valid random sample of returns, as part of the National Research Program the IRS conducts. Basically, even some minor, unexplained glitch in your return can trigger an audit.

Nothing is more helpful to tax filing than great, timely records. However, it's difficult to put those records together at the last minute if you haven't been compiling them all year. Your taxes should be reviewed on a regular — not annual — basis, especially if you're a business owner. "If you wait until April 10 to figure out your entire year, you're either going to make big mistakes or you're going to overestimate things, leave things out and get audited," says Chantel Bonneau, wealth management adviser at Northwestern Mutual.

The IRS is certainly going to want a word with you if you don't file a return — the bare minimum you have to do at tax season. If you owe the IRS and don't pay, you'll be slapped with both late payment and late filing penalties that add up quickly. Even if you owe nothing or have no income, file anyway, says Mark J. Kohler, senior adviser at online tax firm TaxSlayer.

"The IRS is like a boyfriend or girlfriend, if you don't stay in touch, they will assume the worst," Kohler says. "They'll also say bad things about you to their friends."

"Correlation or causation is another debate, but the more money you make, the higher the risk of being audited," Northwestern Mutual's Bonneau says. "If you're making $10 million a year, there's a higher likelihood that you're going to be audited than someone who claims $35,000."

Granted, those wealthier folks tend to be business owners making more deductions that are worth more money, but the IRS knows where the big money is. Back in 2017, the chance of the IRS auditing a person or married couple making less than $500,000 was less than 1 percent. For those making more than $10 million, it was 14.5 percent.

If your earnings suddenly plummet by about half, that could be a trigger for the IRS, as well. Remember, the IRS looks at your entire tax history, so even a reduction in income from year to year could make them suspicious. Considering that a drop from $82,501 a year to $38,700 a year would move you from the 24 percent bracket to the 12 percent bracket, the IRS is going to want to know why they're getting less from you.

According to the IRS, folks who do their taxes on paper are 20 times more likely to make a mistake than those who e-file or get help. Some are small, amendable mistakes like misspelling a name or forgetting a Social Security number. Others, like terrible math, might get the IRS to give you some unwanted attention. Get it right the first time, even if it means paying someone to do it for you.

TaxSlayer's Kohler notes that the easiest way to produce an accurate tax return that keeps the IRS happy is to keep the best accounting records you can. The more detail you can provide, the less the IRS has to ask for.

"Receipts have nothing to do with keeping you out of an audit, but they can certainly reduce the severity of an audit and even reduce the extent and time it may take," Kohler says.

The IRS has no problem with you deducting mortgage interest, property tax, operating expenses, depreciation, and repairs made to a rental property. But if you're sprucing the place up or upgrading appliances and you deduct those expenses, you're double-dipping. The IRS considers those improvements part of depreciation, which means you can only deduct a portion of their expenses.

If you haven't been keeping track of old retirement accounts or brokerage accounts, gains from those accounts could be held against you by the IRS. The one thing that all agents and advisers agree upon is that organization is key to avoiding an audit. If you have an old 401(k) kicking around or think you do, find it.

A 529 plan is a great way to grow college savings tax-free and hand them on to another generation. But tax-free growth doesn't mean the IRS is left out entirely. Whenever you take a distribution from that plan to pay for a student's expenses, you'll receive a 1099-Q form to report to the IRS. The distribution reported on the form might not be taxable, depending on how it was spent. Only tuition and school-related expenses qualify as tax-free. If you don't submit that 1099-Q or if you use that distribution for something other than school, there could be issues.

It is perfectly acceptable to write off investment losses, and Melinda Kibler of Palisades Hudson advises doing so to offset any gains you had this year. "If your losses are greater than your gains, you can use up to $3,000 of loss to reduce your other income, and carry over the amount above $3,000 to future years," she says. However, if your investments are already tax sheltered — either in a retirement plan or in another place where the IRS can't access them — the IRS isn't going to take kindly to you deducting their losses.

When you file a tax return, you also indicate the industry you work in. This allows the IRS to categorize your expenses and look for abnormal expense levels compared to your income.

"Obviously, you would never increase an expense because it wouldn't be noticed, but you certainly should consider reducing an expense if it is far too high and will stand out," TaxSlayer's Kohler says.

There are few ways to avoid an audit in this situation. Overseas banks have to identify American asset holders and provide information to the IRS. If you have at least $50,000, you have to file Form 8938 and let the IRS know what you have. You also have to identify the bank and the highest dollar amount the account was at the previous year. If you comply, there's a chance you'll get audited just for having an account. If you don't, you'll pay penalties and maybe get a court date out of it.

The Motley Fool ran the numbers on 2016 tax deductions and found that the average taxpayer making $50,000 to $100,000 deducted $9,426 in medical expenses, $7,007 in mortgage interest, $3,244 in charitable contributions and $3,195 in state and local taxes. If your deductions are wildly higher than that, the IRS will likely take notice.

Some taxpayers will attach additional statements and comments to their return to explain expenses and oddities. If your file is handed off to an agent for further review, TaxSlayer's Kohler notes that a real human can sometimes choose to bypass your return for an audit because you already provided the support the revenue agent would be asking for. If you don't attach those explanations, though, the IRS may audit you to clarify the situation.

There's money to be saved by filing as a small business, but the simple act of filing as a sole proprietorship can increase your chances for an audit. Kohler notes that filing as an S-corporation or partnership greatly reduces that liability by spreading the responsibility to employees and business partners.

While it's true that you can knock down self-employment taxes by forming an S-corporation, you have to actually pay the shareholder-employees a salary. If your S-corporation is making huge profits and the officers are being paid nothing or a minor amount, chances are you're running headlong into an audit of your business income.

The 1099 form is a blaring alarm for the IRS. Kohler notes that employers should request W-9 forms for all subcontractors before they get paid and issue 1099 forms in January, following proper procedures. You may get away with a late 1099 form here or there, but making a habit of not sending those forms out will practically invite the IRS to your doorstep. "If you already missed the deadline this year, don't let it happen again," Kohler says.

So you've retired and opened your own junk shop or barber shop/salon. You make just about enough to pay the rent, but occasionally pay out of pocket to keep things going. If you're not making a profit, but aren't considered a not-for-profit business, congratulations: The IRS now considers you a hobbyist and may audit you to make sure you aren't taking advantage of business deductions.

"The IRS does not like illogical behavior," says Northwestern Mutual's Bonneau. "If you have a business that shows a huge loss or a loss year after year, they are going to wonder how you are in business." 

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The common refrain is that the IRS believes waitresses and bartenders underreport their income by roughly 84 percent. This is largely because those employees have to create tip records on their own that correspond with records kept by their employers. "You should be very conscious of what your strategy is, how you're going to track your expenses and where you keep your receipts and all of that," Bonneau says.

For freelancers, tax time can be a messy tangle of different employers and 1099 forms, and a missed 1099 form for even a minor amount can catch the IRS' attention once it cross references with an employer's deduction. Bonneau says tracking your employers and their paperwork is of utmost importance in the gig economy.

"There are so many people now who are self-employed or freelancers and are filing a self-employed tax return, which in and of itself makes you more likely for audit than if you're just a traditional W-2 employee," she says. 

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If a business pays you less than $1,500 in a year or a bank account produces even 50 cents in interest, you need to report it. Save pay stubs, print bank statements and look for 1099 forms from employers and financial institutions. "Hopefully you're doing work with people who are also doing their taxes correctly because, if they mislabel you, everything has to be cross-referenced through the IRS," Bonneau says.

We don't mean deduct the mileage on your car or even the fuel expenses. We're talking about people who believe that driving their car a lot for work entitles them to deduct the entire cost of its operation and depreciation. Unless you purchase and use that vehicle specifically for work — a contractor's truck comes to mind — there are rules about what you can and can't deduct. Those rules get even more stringent depending on if you own or lease the car. "Rarely is a car used 100 percent for business by a small business owner," says Bonneau.

For folks who own or operate an S-corporation, this is worth your attention. You should be filing payment reports anyway, but employee IRS withholdings are sacred to the IRS: It's cash they'll have on hand immediately. If you get behind on your withholdings, you'd better hope it's an IRS agent who knocks on your door. "It's not just an audit we're worried about … we're talking jail time," says TaxSlayer's Kohler.

It doesn't matter if you're trying to deduct mileage, supplies, charitable donations, or your mortgage interest: Close doesn't count. Keep your receipts and billing statements, calculate the numbers down to the last cent and submit that. Just because the threshold for a deduction is a round number doesn't mean you can just round right up to it.

"How many people actually spend $400 on office supplies in a given year?" Kohler says. "I don't think you could go through Staples and create one or two purchases that exactly add up to $400 even if you tried."

You shouldn't round up your charitable deduction, but you shouldn't declare an exorbitant amount, either. No, donating your late grandmother's dining room furniture to Habitat for Humanity or your late uncle's car to Kars 4 Kids doesn't mean you donated the original retail value of those items. The IRS keeps an eye on those deductions and is not all that gullible. "If you make $40,000 a year and contribute $28,000 to charity, that may make the IRS look and see what's going on there," Bonneau says.

You are entitled to a home-office deduction if you're self-employed, work from home and can calculate the square footage, utilities and other expenses of your office space. While you can try to determine which portion of a home's expenses, taxes, insurance and depreciation is dedicated to a home office, a simplified version multiplies the square feet of the room by $5 (if the total size is 300 square feet or smaller). Just watch out if the expenses inflate beyond that multiple of $5.

"Have a procedure/calculation and remember 'pigs get fat and hogs get slaughtered,' " says TaxSlayer's Kohler. "Don't get greedy."

Banks and various other businesses are required to notify the IRS of large cash transactions, generally $10,000 or more. If your name is associated with numerous large transactions, don’t be surprised if the IRS comes knocking wanting to find out if the money was tied to drug dealing or other nefarious activities.

If you're in costume design and you only use your computer to send invoices and do the occasional office task, that may not warrant a full deduction. Finding an accountant or tax preparer with experience in your specific industry makes it far easier to determine what constitutes a legitimate business expense and what may be a reach. "Make sure you have a game plan, as you should with all of your finances, instead of just winging it, deducting it and hoping you don't get caught," Bonneau says.

Those expenses should look normal, well-balanced, and conform to your income level and industry. If you are a sales representative on the road hawking products, those type of expenses will appear standard. However, if you run an Etsy page out of your basement in the evenings, daily dining and golfing expenses aren't typically part of the deal. Furthermore, entertainment expenses are no longer deductible under the 2017 tax law.

"Bottom line, don't be afraid to take an expense that you're entitled to, especially if you kept good records," TaxSlayer's Kohler says. "But also make sure you're filing your reports and tax return doesn't stand out. This isn't the prom. You want to stand in the corner and not get asked to dance."