How to Avoid an IRS Audit: Red Flags to Watch

Introduction

The IRS audits less than 1% of tax returns, but certain red flags increase the risk of an audit.
Whether you are an individual taxpayer, freelancer, or business owner, knowing what triggers IRS
scrutiny can help you file accurately and avoid penalties.

This guide explains common IRS audit triggers, steps to prevent an audit, and what to do if you
receive an IRS notice.

 What Triggers an IRS Audit?

1.1 Reporting High Income (IRC §7602)

•  The IRS audits high-income earners more frequently.
• Taxpayers earning $500,000+ face higher audit risks.

Action Step: Keep detailed income records and supporting documents.

1.2 Claiming Too Many Deductions (IRC §162)

• Large business deductions that don’t match your income level raise red flags.
•  Example: A freelancer with $50,000 income claiming $40,000 in deductions may get
  audited.

Action Step: Only deduct legitimate business expenses and maintain receipts and records.

1.3 Excessive Charitable Donations (IRC §170)

•  If charitable contributions seem disproportionate to income, the IRS may request proof.
•  Donations over $500 require Form 8283.

Action Step: Keep written acknowledgment from charities for donations over $250.

1.4 Home Office Deduction Misuse (IRC §280A)

•  The home office deduction applies only to spaces used exclusively for business.
• Claiming a large home office for a small business may lead to an IRS review.

Action Step: Use the simplified deduction ($5 per square foot, up to 300 sq. ft.).

1.5 Large Cash Transactions (IRC §6050I)

•  Deposits over $10,000 in cash must be reported to the IRS.
•  Frequent large deposits without a clear source may trigger audits.

Action Step: Document all large cash transactions with bank records and invoices.

1.6 Rounding Numbers Instead of Exact Amounts

• The IRS prefers actual numbers rather than rounded figures.
•  Example: Reporting $10,000 in expenses instead of $10,136 can look suspicious.

Action Step: Use exact numbers from receipts, invoices, and bank statements.

1.7 Mismatched Income on 1099s or W-2s (IRC §6721 & §6722)

• The IRS automatically matches reported income to W-2s and 1099s.
•  If your reported income doesn’t match IRS records, an audit may follow.

Action Step: Double-check Form 1099-NEC, Form 1099-K, and W-2s before filing.

1.8 Claiming 100% Business Use of a Vehicle (IRC §274(d))

• The IRS rarely believes a car is used only for business.
•  Business owners must keep a mileage log to justify deductions.

Action Step: Use a mileage tracking app (MileIQ, Everlance) and report actual mileage.

1.9 Foreign Bank Accounts Not Reported (FBAR & FATCA Rules)

• U.S. taxpayers must report foreign financial accounts over $10,000 using FBAR (FinCEN
  Form 114).
• Failing to report foreign assets may trigger an IRS audit and penalties.

Action Step: Use Form 8938 (FATCA) and FBAR for foreign accounts.

1.10 Large Business Losses for Multiple Years (IRC §183 – Hobby Loss Rule)

•  The IRS may classify a business as a hobby if it shows losses for multiple years.
• Example: A business with no profit for 5 years may lose tax benefits.

Action Step: Keep detailed records of business activities to prove profitability efforts.

How to Reduce IRS Audit Risk

Step 1: Report All Income Accurately

•  Use Form 1099-NEC, 1099-K, and W-2s to match IRS records.
•  Keep invoices and digital transaction logs.

Step 2: Keep Detailed Business Expense Records

• Save receipts, bank statements, and invoices.
•  Track mileage, home office use, and travel expenses.

Step 3: File Taxes on Time and Pay Estimated Taxes

• The IRS flags late or incomplete returns.
•  Self-employed taxpayers should pay quarterly estimated taxes (Form 1040-ES).

Step 4: Use a CPA for Tax Preparation

•  A CPA ensures accurate reporting and audit-proof documentation.
•  Professional tax filing reduces the chances of IRS red flags.

 What to Do If You Receive an IRS Audit Notice?

Step 1: Don’t Ignore the IRS Letter

•  Respond by the deadline on the notice.
• Failure to respond may lead to penalties and additional scrutiny.

Step 2: Gather Supporting Documents

• Income records (W-2, 1099-NEC, invoices).
• Business expense receipts, bank statements, and mileage logs.

Step 3: Work with a CPA or Tax Attorney

•  A CPA or Enrolled Agent (EA) can negotiate with the IRS on your behalf.
• Avoid making statements without legal guidance.

Step 4: Request an Extension If Needed

•  Use Form 4868 (individuals) or Form 7004 (businesses) for extra time.

Step 5: Consider an IRS Payment Plan

•  If taxes are owed, apply for an IRS installment agreement (Form 9465).

Common Myths About IRS Audits

1. Myth: Filing an Extension Increases Audit Risk

•  Truth: Filing an extension does not increase audit chances.

2. Myth: Claiming a Home Office Deduction Triggers an Audit

•  Truth: The IRS allows home office deductions, but they must be legitimate.

3. Myth: Only High-Income Earners Get Audited

•  Truth: The IRS audits all income levels, but higher incomes face higher scrutiny.

4. Myth: Cash Transactions Avoid IRS Scrutiny

• Truth: Large cash deposits over $10,000 must be reported.

5. Myth: Amending a Return Leads to an Audit

• Truth: Correcting mistakes with an amended return does not automatically trigger an audit.

Frequently Asked Questions (FAQs)

1. How long does the IRS have to audit a tax return?
The IRS has 3 years from the filing date to conduct an audit, but it may extend to 6 years for
substantial errors.

2. What happens if I ignore an IRS audit notice?
Ignoring an audit notice can lead to tax penalties, interest, and IRS collection actions.

3. Can I deduct business losses every year?
Yes, but repeated losses over multiple years may cause the IRS to classify your business as a hobby.

4. Do small businesses get audited more than individuals?
Yes, small businesses face higher audit risks, especially if reporting large deductions or cash
transactions.

5. Should I respond to an IRS audit alone?
It is best to work with a CPA or tax attorney to ensure a proper response.

 Conclusion

Avoiding an IRS audit starts with accurate tax reporting, proper documentation, and working with
a CPA. By understanding IRS red flags, you can reduce your audit risk and ensure compliance.

For professional tax audit assistance, schedule a meeting with our CPA Anshul Goyal by clicking at
https://calendly.com/anshulcpa/ now.