Receiving an IRS audit notice can be stressful, but understanding what triggers audits and how to properly document your return can significantly reduce your risk. As an Enrolled Agent, I’ve guided numerous clients through audits and helped many more avoid them entirely through proper preparation.
What Actually Triggers an IRS Audit?
The IRS uses a computerized system called the Discriminant Information Function (DIF) to score tax returns based on the likelihood of additional tax revenue. Returns with unusual patterns or significant deviations from statistical norms for your income level receive higher scores and increased scrutiny.
Common Audit Red Flags
Disproportionately High Deductions: When deductions seem excessive relative to income—such as claiming $30,000 in charitable contributions on a $75,000 income—the IRS takes notice. While legitimate deductions should always be claimed, ensure you have proper documentation.
Home Office Deduction: This legitimate deduction has historically attracted IRS attention due to frequent misuse. The space must be used regularly and exclusively for business. Using your guest bedroom as an office during the day while hosting visitors at night doesn’t qualify.
Round Numbers: Repeatedly using round numbers ($5,000, $10,000) suggests estimation rather than actual record-keeping. Use precise amounts from receipts and statements.
Cash-Heavy Businesses: Businesses dealing primarily in cash—restaurants, salons, construction companies—face higher audit rates because cash transactions are harder to verify and easier to underreport.
Substantial Income: Statistically, higher income returns receive more scrutiny. Individuals reporting over $200,000 annually have notably higher audit rates, and those exceeding $1 million face even greater examination.
Unreported Income: The IRS receives copies of all 1099s and W-2s. Failing to report this income virtually guarantees correspondence. Their computers automatically match reported amounts against your return.
Large Business Losses: Claiming business losses year after year may prompt the IRS to question whether your venture is a legitimate business or a hobby. Hobbies don’t generate tax-deductible losses.
Foreign Accounts: Undisclosed foreign bank accounts or income from overseas sources attract significant IRS interest, especially with enhanced international reporting requirements.
Protecting Yourself: Documentation Best Practices
The foundation of audit protection is meticulous documentation:
Keep Everything: Maintain receipts, invoices, bank statements, canceled checks, and credit card statements for at least three years (seven years for more serious situations). Digital scanning creates convenient, searchable backups.
Document Business Mileage: Keep a contemporaneous log showing date, destination, business purpose, and miles traveled. Smartphone apps can simplify this process.
Substantiate Charitable Donations: Cash donations require bank records or written acknowledgment from the charity. Donations over $250 require written substantiation from the organization. Noncash donations over $500 require additional forms, and those exceeding $5,000 typically require professional appraisals.
Separate Business and Personal: Maintain separate bank accounts and credit cards for business activities. Commingling funds makes it difficult to substantiate legitimate business expenses.
Explain Unusual Items: If your return includes unusual circumstances—such as large medical expenses, casualty losses, or one-time income events—consider attaching explanatory statements to your return providing context.
What to Do If You’re Audited
First, don’t panic. Most audits are correspondence audits conducted by mail, not intimidating in-person examinations. Second, respond timely to all IRS notices—ignoring them only worsens the situation.
This is where having an Enrolled Agent becomes invaluable. As your authorized representative, I can:
- Communicate with the IRS on your behalf
- Review which documents the IRS actually needs
- Present your case in the most favorable legal light
- Negotiate outcomes and explore appeals if necessary
- Allow you to avoid stressful direct interactions with IRS agents
The Best Audit Strategy: Accurate Returns
The most effective audit protection is filing accurate, honest returns with proper documentation. Taking aggressive positions on questionable deductions isn’t worth the stress and potential penalties of an audit.
If you’re uncertain about the legitimacy of deductions or concerned about audit risks in your specific situation, consult with a tax professional before filing. As an Enrolled Agent, I can review your return, identify potential issues, and ensure you’re claiming every legitimate deduction while minimizing audit risk.
Contact me today to discuss how proper tax planning and preparation can give you confidence in your returns and peace of mind throughout the year.
