The Most Common IRS Audit Triggers and How to Avoid Them

March 04, 2025
The Most Common IRS Audit Triggers and How to Avoid Them

 

Introduction

An IRS audit is a review of an individual's or business's financial records to ensure compliance with tax laws. While the chances of an audit are relatively low, certain red flags significantly increase the likelihood of IRS scrutiny. Understanding the most common audit triggers and how to avoid them can help taxpayers stay compliant and minimize their risk of facing an IRS examination.

 

1. High Income Levels

The higher your income, the greater your chances of an IRS audit. The IRS focuses on high-income taxpayers because larger earnings often mean more deductions, investments, and complex financial transactions.

  • Audit Risk:
    • Taxpayers earning $500,000 to $1 million: ~0.6% audit rate.
    • Taxpayers earning over $1 million: Audit rate increases significantly.
  • How to Avoid It:
    • Ensure accurate reporting of all income, including earnings from freelance work, investments, or cryptocurrency transactions.
    • Keep detailed records of all deductions and credits claimed.

 

2. Unreported Income (Mismatched 1099s & W-2s)

The IRS receives copies of all tax forms (e.g., W-2s, 1099s) from employers, banks, and brokers. If the income you report on your tax return doesn’t match IRS records, it’s an automatic red flag.

  • Common Issues:
    • Forgetting to report freelance or gig work from a 1099-NEC or 1099-K.
    • Omitting dividends, capital gains, or interest income from 1099-DIVs or 1099-INTs.
    • Misreporting self-employment earnings.

How to Avoid It:

  • Cross-check all income with IRS records before filing.
  • Use tax software or a CPA to ensure complete reporting.

 

3. Large or Unusual Deductions

Taking unusually high deductions compared to your income level can trigger an IRS audit. The IRS uses automated systems to flag taxpayers whose deductions exceed typical amounts for their income bracket.

  • Common Problem Areas:
    • Charitable Donations: Claiming unusually high deductions compared to income.
    • Business Expenses: Writing off personal expenses as business deductions.
    • Home Office Deductions: Claiming excessive home office space.
  • How to Avoid It:
    • Keep detailed records of all deductions, including receipts and supporting documents.
    • Follow IRS guidelines to properly calculate home office deductions and other expenses.

 

4. Excessive Business Losses (Schedule C Filers)

The IRS closely scrutinizes self-employed individuals and small business owners who consistently report business losses. If your business shows repeated losses, the IRS may reclassify it as a hobby, making deductions non-deductible.

  • How to Avoid It:
    • Keep detailed records of business expenses and ensure they are ordinary and necessary.
    • Maintain a profit motive—show occasional profits to avoid IRS classification as a hobby.
    • Consider forming an LLC or S-Corp for credibility and tax advantages.

 

5. Claiming 100% Business Use of a Vehicle

Claiming that your vehicle is used 100% for business raises a red flag. The IRS knows that most people use their car for both personal and business purposes.

  • How to Avoid It:
    • Maintain a mileage log detailing business trips.
    • Only claim business-related mileage and use the IRS standard mileage rate.

 

6. Large Cash Transactions & Deposits

Depositing or withdrawing $10,000 or more in cash from a bank account triggers an automatic Currency Transaction Report (CTR) to the IRS. Repeated large deposits can raise IRS suspicions of tax evasion or money laundering.

  • How to Avoid It:
    • Ensure that all cash income is properly reported.
    • Avoid making structured deposits (e.g., $9,900 multiple times) to bypass reporting requirements—this is called structuring and is illegal.

 

7. Claiming Too Many Rental Property Losses

Rental property losses can offset taxable income, but excessive losses relative to rental income often trigger an audit.

  • How to Avoid It:
    • Ensure that all expenses are legitimate and backed by records.
    • If actively managing rental properties, you may qualify for real estate professional tax benefits—meet the 750-hour rule to claim additional deductions.

 

8. Foreign Bank Accounts & Unreported Overseas Assets (FBAR & FATCA Violations)

The IRS aggressively enforces foreign account reporting laws under FATCA (Foreign Account Tax Compliance Act) and FBAR (Report of Foreign Bank and Financial Accounts).

Common Triggers:

  • Failing to file FBAR (FinCEN Form 114) if foreign bank account balances exceed $10,000.
  • Not reporting foreign financial assets over $200,000 (for expats) on Form 8938.
  • Unreported foreign rental income.
  • How to Avoid It:
    • Report all foreign accounts and income, even if no tax is due.
    • Work with a tax professional experienced in expat tax compliance.

 

9. Cryptocurrency Transactions Without Proper Reporting

The IRS actively tracks cryptocurrency transactions through exchanges and requires taxpayers to report all crypto sales, trades, and staking rewards.

  • How to Avoid It:
    • Report all crypto transactions on Form 8949 and Schedule D.
    • Keep detailed records of crypto buys, sales, and staking rewards.
    • Use crypto tax software to generate accurate reports.

 

10. Making Errors or Omitting Information on Your Tax Return

Simple mistakes—such as math errors, missing signatures, or failing to include required forms—can result in an IRS audit.

  • How to Avoid It:
    • Double-check all numbers and calculations before filing.
    • Use tax preparation software or hire a CPA for accuracy.
    • Ensure all required forms (e.g., W-2s, 1099s, 1098s) are included in your filing.

 

Conclusion

While an IRS audit may seem intimidating, understanding the most common triggers can help you stay compliant and avoid unnecessary scrutiny. Proper record-keeping, accurate reporting of income and deductions, and seeking professional tax guidance can significantly reduce the risk of an audit.

Tax Partners can assist you in ensuring your tax filings are accurate and compliant, minimizing the risk of an IRS audit.

 

This article is written for educational purposes.

 

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

 

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.

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