IRS audit red flags – why IRS audits occur

Almost everyone dreads getting audited by the IRS, even taxpayers who have submitted accurate tax returns. Fortunately, most taxpayers are highly unlikely to get audited. The Internal Revenue Service (IRS) audits less than 1% of all tax returns in a given year. However, taxpayers should be careful to avoid certain IRS audit red flags that can increase their risk of being audited. If you have questions about an IRS audit or another tax issue, you can learn more by contacting the experienced Mississippi tax attorneys of Damiens Law at (601) 957-9672.

What causes you to get audited by the IRS?

The IRS looks for several red flags when determining which tax returns to audit. Taxpayers should be aware of these red flags and how to avoid them to minimize their risk of being audited by the IRS.

Failure to report all taxable income

Filing a 100% accurate tax return is the best way to minimize the chance of being audited. The IRS receives copies of all tax forms issued to taxpayers, so all income related to these forms must be reported. Taxpayers should also be careful to report all other taxable income, even if they have not received a 1099 or W-2 for it. Common examples of other taxable income include gambling winnings or freelance work.

The IRS will typically compare the reported income items from tax forms with the amount of income claimed on a tax return. If an agent sees missing income, they will usually begin the audit process by sending a letter to the taxpayer, asking them to clarify the missing items and providing an opportunity to correct any mistakes.

Claiming high deductions, credits, or losses

Taxpayers who claim deductions, credits, or losses that are disproportionately high compared to their income may be more likely to receive an IRS audit. The IRS consults occupational codes to determine the normal amount of business tax deductions for various industries. Tax returns that show more than 20% over the norm for the industry are more likely to be reevaluated and audited.

This red flag applies to both businesses and employees who claim business expenses on their returns, such as accommodation and meals during business trips. While these expenses are deductible, amounts that far exceed the average are more likely to be scrutinized. High charitable deductions are also more likely to trigger an audit, as the IRS also calculates average charitable donations for various income levels.

High yearly income

Taxpayers with yearly earnings of $200,000 or more are much more likely to be audited by the IRS. In 2021, the IRS audited approximately 1% of taxpayers who earned less than $200,000, while taxpayers who earned more were audited at a rate of about 4%. The likelihood of being audited continues to rise after that yearly income, with 12.5% of those making $1 million or more being audited in the same year. This rule applies in the business world as well. In 2021, 1% of corporations with under $10 million in assets were audited, compared to 17.6% of the corporations with assets above that mark.

There are two main reasons why higher earnings are more likely to involve audits. First, higher incomes often involve more complicated tax returns, which increases the likelihood of a mistake that could trigger an audit. In addition, the IRS operates like a business in the sense that they want to maximize its return on investment each year. An audit of a higher income tax return can result in more penalties and interest for the IRS. If you have questions about avoiding an audit as a high-income individual or any other IRS audit red flags questions, you can learn more by contacting the dedicated Mississippi tax attorneys of Damiens Law at (601) 957-9672.

Foreign account rule violations

Under the Foreign Account Tax Compliance Act (FACTA), the  Internal Revenue Service has established strict guidelines regarding foreign bank accounts for American taxpayers. Failing to follow FACTA requirements substantially increases the risk of receiving an IRS audit. FACTA requires some U.S. taxpayers who hold financial assets outside of the United States to report their assets to the IRS. In most cases, FACTA only applies to taxpayers who hold over $50,000 in assets. However, there are some exceptions in which that threshold may be raised.

In addition to these individual legal obligations, foreign banks are also required to identify Americans who hold foreign assets and provide information on those assets to the IRS. When individuals fail to report foreign assets on their tax returns, they are much more likely to get audited since the IRS likely already has been notified of the assets by the taxpayer’s financial institution.

Filing under schedule C

Sole proprietors and other self-employed individuals typically file their taxes under Schedule C. Filing under this designation often involves claiming unique deductions that do not apply to most other taxpayers, such as expenses for home office supplies, travel costs, meals, and entertainment.

IRS agents are on the lookout for Schedule C filers who claim excessive deductions beyond those that are directly related to their work. Schedule C filers are also more likely to underreport income, so filing under this designation may increase the chances of an audit.

Non-Filers

Failure to file a tax return is a common IRS audit trigger. The IRS has recently made high-income non-filers a top enforcement priority. Specifically, the IRS is pursuing individuals who have earned more than $100,000 but failed to file a tax return. If the IRS finds out that a return was not filed during a year with reportable income, they will typically contact the taxpayer and attempt to find a resolution to the debt, such as a payment plan or offer in compromise. However, those who refuse to negotiate with the IRS may face severe penalties, such as liens, levies, and sometimes criminal charges.

What are the odds of getting audited by the IRS?

The odds of getting audited by the IRS vary depending on income level. According to the Internal Revenue Service (IRS)’s statistics, the following audit rates applied for the tax year 2019:

• Returns with Earned Income Tax Credit (EITC) – 0.8%
• No total positive income – 1.1%
• $1-$25,000 – 0.4%
• $25,000-$50,000 – 0.2%
• $50,000-$75,000 – 0.2%
• $75,000-$100,000 – 0.2%
• $100,000-$200,000 – 0.2%
• $200,000-$500,000 – 0.2%
• $500,000-$1 million – 0.6%
• $1 million-$5 million – 1.3%
• $5 million-$10 million – 2.0%
• Over $10 million – 8.7%

As these statistics show, the highest-income earners have the highest odds of getting audited by the IRS. However, it is also worth noting that those on the other end of the earnings spectrum are also more likely to get audited than those who fall in the middle. Those with no positive income are more than five times as likely to face an audit than those who earn between $25,000 and $500,000.

Should I worry about getting audited?

While receiving an IRS audit is never a pleasant experience, most taxpayers should not worry about getting audited. Ensuring that your taxes are completely accurate can help reduce the risk of an audit and help ensure that you can easily resolve the matter if the IRS has questions about certain parts of your tax return. A tax audit also does not always mean the beginning of a difficult battle with the IRS. Many audits are easily resolved by providing documentation about the portion of the tax return in question, such as receipts for business expense deductions.

Taxpayers who want to minimize their risk of an audit often hire professionals for guidance, such as tax attorneys and accountants. These professionals understand the various intricacies of the tax system. A tax attorney can help ensure that your taxes are accurate and provide legal guidance during IRS audits and other disputes.

What should you do if you get audited by the IRS?

Even taxpayers who carefully file accurate returns are at risk of being audited. If you have recently been audited by the IRS, here are some things to consider:

• Understand the type of audit – Most IRS audits are sent through the mail, but they also may issue an office or field audit, which involves meeting face to face. Simpler audits are typically handled through the mail, while more complex returns may result in an office or field audit. Audited taxpayers should understand which portions of their tax returns have been audited.
• Respond to the questions from the IRS – Taxpayers should prepare a full response to all items that the IRS is questioning in their audit.
• Submit requested information on time – All requested information and documents should be submitted by the deadlines mentioned in the audit.
• Consider an appeal – Taxpayers who disagree with the audit have the right to file an appeal.

Learn more from our Mississippi tax attorneys

If you have questions about IRS audit red flags or another tax matter, the team of Mississippi tax attorneys at Damiens Law are here to help. We provide our clients with legal guidance on a wide range of tax matters. Contact us today at (601) 957-9672 for a free initial consultation.