Knowing what can trigger a tax audit and how to work around it is immensely vital.
In this article:
- Applying for a Home Office Deduction
- IRS Receiving Discrepancies for Employee’s Tax Reports
- Having Big Charity Deductions
- Reporting Travel Expenses Tagged as Purely for Business
- Filling Out Rental Property Expenses Inefficiently
- Documenting a High Income Leap
- Stating Very Low or No Income
- Tax Report Showing a Discrepancy Between Income and Net Worth
- Sending a Schedule C Reaching All the Business Limits
9 Tax Audit Red Flags Taxpayers May Want to Know
1. Applying for a Home Office Deduction
Getting a home office deduction can lower the income bracket of a taxpayer dramatically. However, this tax deduction method can lead to abuses from taxpayers.
The construction of a home office, usually for those who work as freelancers or have businesses, is quite costly. This big expense can raise a red flag as cases of over-reporting or inappropriate use of materials pile up the IRS records.
The IRS has internal records of how much a home office space can cost in a particular area, and showing a big variance in relation to cost and space can easily trigger a tax audit.
The construction expense is not the only issue the IRS looks at frequently. Bills related to operating a home office is another leading cause of a tax audit.
For example, if your home office space takes only 20% of your total residence, then the bills should only correspond to 20% of the sum as well. While we do know the utility bills of a home office are higher than residential space, the IRS looks at the space allotted, not the actual expenditure.
To avoid this, a taxpayer can ask for separate utility bills for his or her office space
Knowing the possible home office tax deductions can really help taxpayers get the IRS off their backs.
Home office credits are also another important matter taxpayers should concern themselves with. After a taxpayer exhausts all tax deductions, a home office tax credit can lower the total tax bill further.
2. IRS Receiving Discrepancies for Employee’s Tax Reports
Employed taxpayers are not the only ones responsible for reporting their salaries and benefits. For other entities, your income is their expense, and they have to report said expenses to the IRS.
Employers have to send a separate W-2 detailing an employee’s salary. Client companies and taxpayers also send Form 1099 as well to the IRS.
As companies and individuals send a tax report to the taxpayer, the IRS also receives its own copy. This dual receipt of tax forms makes tax discrepancies easy for the IRS to find.
If a taxpayer has a concern with the accuracy of his or her tax filing, finding the best way to reach the IRS is a top priority. Making sure your tax reports coincide with what the IRS has will lower the chances of a tax audit.
In fact, this act of reaching out will show sincerity in reporting taxes accurately, as well as provide information needed to make the corrections.
3. Having Big Charity Deductions
Sometimes, a taxpayer who is too generous may seem suspicious to the IRS.
Until December 31, 2025, there is a maximum charity or donation limit set by law depending on the status of the taxpayer. The limits are $12,000 for single taxpayers, followed by the household head at $18,000 and lastly, $24,000 for both spouses who file their taxes jointly.
Using the highest possible deductions by itself does not look suspicious. However, going above the average tax deductions for your income bracket can raise some eyebrows.
The IRS knows the average donation levels for people within the same income brackets. Lastly, the IRS also knows what charities and non-profits are recipients of suspicious money.
To avoid becoming a suspect, a taxpayer can opt to donate via checks rather than cash. Checks provide not just legitimacy as they pass through banks, but also records and receipts.
4. Reporting Travel Expenses Tagged as Purely for Business
Travel expenses for business operations can add up, which means having them as tax-deductible can dramatically lower taxes. On the other hand, such reports have a history of abuse in the IRS records, since mileage does not necessarily tell the whole story of the journey.
There are two ways to lower the suspicion of the IRS.
The first is by using their own standard rates rather than the current market prices. The second is not making all fuel expenses as business deductions.
Using the standard mileage rates set by the IRS can help. The IRS mileage rates usually are higher than market prices, which is another benefit for taxpayers as deductions are bigger.
Lastly, the IRS may find it suspicious if a personal car, not a company vehicle, has gas bills and large mileage purely for business.
Rather than risk an audit, be honest with your report. Do not try to squeeze in deductions that are not supposed to be there.
5. Filling Out Rental Property Expenses Inefficiently
Reporting rental income has its own system and regulations that can complicate things.
The documentation of receipts for income and expenses is usually a time-consuming task. Plus the different standards and categories set by the IRS can easily give any landlord a headache.
For example, some expenses are considered deductible for the year the taxpayer paid for it. Examples include repairs, employee wages, and insurance payments.
On the other hand, taxpayers must amortize some expenses over a few years rather than have one big deduction for a single tax filing session. Some common examples are property depreciation and the mortgage interest, which has its own complex system.
6. Documenting a High Income Leap
Getting a sudden leap in income is something to celebrate. However, the IRS looks at such dramatic increases warily.
The IRS grows suspicious not only when there is a significant increase in salary for employed people, but also for other sources of income. Businesses, in particular, raises eyebrows, especially if the new business is a red flag itself.
What are the red flag industries? Any businesses that have a history or have a high chance of involving money laundering.
Two main categories exist.
The first one deals with very liquid businesses with little supervision regarding receipts.
Examples of this include cleaning services, agencies, taxis, and even bars. Most of the time, tips and “gig” income have loose regulation.
The second grouping consists of any businesses that deal with currencies. The usual activities include forex and foreign investments, especially with other suspicious countries.
7. Stating Very Low or No Income
On the other side of the spectrum, a sudden drop in income looks suspicious.
Of course, it is understandable if there are tragic changes, like unemployment or bankruptcy. However, if there are no changes in financial status or income stream, a drastic decrease may seem like a taxpayer is hiding something.
To the IRS, a sudden change in income brackets without substantial reason may seem like underreporting of AGI. A lower AGI means a lower income tax bracket.
The IRS wants to prevent anybody from manipulating the system by scheming in this manner.
AGI Definition: It is short for Adjusted Gross Income, which is the sum of the total gross income minus all gross tax deductions. The public usually refers to this as the net income.
8. Tax Report Showing a Discrepancy Between Income and Net Worth
A taxpayer with a high net worth, meaning the value of all assets minus liabilities, usually has a high income. In order to maintain a comfortable lifestyle, income must keep up with expenses.
Again, the guiding principle “the nail that stands out gets hammered” applies to this case. The IRS has numerous records as well as accurate algorithms to see if income and wealth do not make sense.
Smart taxpayers should know more about a Taxpayer Advocate Service as part of their preparation. Taxpayers should not receive penalties just because they are doing really well so a professional can help them sort out a viable strategy.
9. Sending a Schedule C Reaching All the Business Limits
A Schedule C is a tax form the IRS requires from self-employed taxpayers. Due to the nature of the people working as self-employed individuals or sole proprietors, tracking expenses and income is a bit more complex.
It is not often a self-employed taxpayer exhausts all the limits in a Schedule C. A Schedule C has its own set of deductions compared to the ones in the Form 1099.
Sometimes, the IRS checks to see if the taxpayer should use a Schedule C instead of a Form 1099. Other times, they want to make sure the taxpayer accurately fills out the said Schedule C.
These 9 triggers are what the IRS usually looks for to decide whether or not a tax audit is in order. A taxpayer can avoid these triggers completely by asking themselves what would the IRS think if they report a specific deduction.
Even if the taxpayer is not hiding anything, a simple blunder can trigger a tax audit, so having an expert set of eyes look at tax reports can really help.
What are your thoughts about tax audits? Do you know other possible tax audits? Let us discuss in the comments section below.