No one wants to get in trouble with the IRS. An audit or investigation can be stressful, time-consuming, and potentially very costly if you’re found to owe additional taxes, penalties, or interest. While the vast majority of Americans file their taxes honestly and accurately, mistakes do happen. And in some cases, taxpayers deliberately try to avoid paying what they owe through fraudulent refund claims or hiding income. So what types of red flags tend to catch the attention of the IRS and get you into hot water? Here’s an overview of some of the main triggers that could potentially prompt the IRS to take a closer look at your tax return.
Claiming incorrect deductions or credits
One of the fastest ways to draw IRS scrutiny is to claim deductions, exemptions, or credits that you’re not actually eligible for. With deductions, this could involve claiming personal expenses as business deductions, claiming deductions for expenses you never actually incurred, or inflating the amounts of actual deductions. With tax credits like the Earned Income Tax Credit or Child Tax Credit, errors can occur if your eligibility status changes and you incorrectly claim credits you’re no longer entitled to based on income or qualifying dependents. The IRS checks returns against third-party documentation like W-2s and 1099s to verify incomes and deduction amounts. Improper deduction and credit claims are a major red flag.
Not reporting all taxable income
The IRS compares the income you report on your return against the income reported to them by third parties like employers and banks. Even if you leave off income accidentally or because you’re unsure if it’s taxable, this income discrepancy gets flagged. Common unreported income issues include:
- Forgetting to report self-employment or “gig economy” income
- Not reporting cash income earned from tips, services, or informal work
- Failing to report all income sources if you have multiple jobs
- Not reporting income from investments, rents, royalties, or prizes/awards
If the difference is substantial, it could trigger an audit. Always be sure to report all taxable income, even if a 1099 wasn’t issued.
Math errors
Simple math mistakes are one of the most common reasons for an IRS notice. This could involve errors in tallying up incomes, deductions, or credits, as well as transposition errors when transferring figures from one form to another. Double-check your return and make sure all your numbers match your supporting documents.
Repeating questioned items year to year
If you’ve been previously flagged for an error or questionable deduction/credit, avoiding the same issue in subsequent years is important. Repeated errors make it seem like you’re intentionally trying to push through inappropriate claims rather than correcting innocent mistakes.
Issues related to reporting business income and expenses
Business owners face greater complexity when filing their taxes. The IRS pays close attention to several areas that are frequently problematic:
Not reporting all business income
Just like personally, failing to report all your business income can raise red flags, especially if amounts differ substantially from what is reported on 1099 forms. Make sure you have records of all income streams.
Claiming personal expenses as business deductions
Most audits of small business tax returns find issues with expenses incorrectly claimed as business deductions. Things like family vacations, entertainment costs, vehicle expenses for personal mileage, and home office spaces that are not exclusively used for business can be subject to extra scrutiny.
Not filing 1099 forms
If you paid over $600 to any unincorporated contractor or LLC over the course of a tax year, you’re required to issue them a 1099 at the end of the year. Failing to do so when the IRS knows you made reportable payments can lead to penalties.
Questionable hobby loss claims
If your business consistently loses money year after year, the IRS may determine it’s actually a hobby rather than a for-profit business. Limiting your losses from a hobby can trigger an audit. Make sure you’re running your business in a way that shows you intend to make a profit.
Issues related to international activity
Global transactions and foreign assets or accounts come with additional reporting requirements and greater IRS scrutiny:
Not reporting foreign income or accounts
U.S. citizens and residents are required to report worldwide income, regardless of where it was earned. Foreign banks accounts over $10,000 must also be reported. Failing to do so can lead to severe penalties.
Improper foreign tax credits
If you paid tax on income earned in a foreign country, you can claim a credit for those taxes on your U.S. return. Improperly calculated credits may draw scrutiny.
Transfer pricing manipulation
If you own international operations, the IRS watches for pricing manipulation between entities to shift profits to lower tax jurisdictions. Appropriately document your transfer pricing methodology.
Abusing offshore accounts
Hiding money in offshore accounts is illegal. All income must be reported, and avoidance schemes like improper Roth IRA rollovers to foreign accounts can lead to big penalties.
Signs of tax evasion or fraud
While minor mistakes will probably just generate IRS notices or relatively routine audits, there are some more serious red flags that suggest intentional efforts to deceive:
- No records or falsified records
- Inability to support deduction/credit claims
- Lying about income sources or amounts
- Claiming personal credits based on false dependents
- Fake businesses or sham expenses
- Using multiple Social Security numbers
Deliberate tax evasion can potentially be charged as criminal fraud leading to fines or even jail time in extreme cases. Even unintentional tax fraud can produce severe penalties.
Ways to avoid IRS trouble
While anyone can make an occasional innocent mistake, you can reduce your audit risk by:
- Keeping excellent records that document incomes, deductions, business expenses, etc.
- Reviewing returns carefully before filing
- Consulting a tax professional if you have complex returns
- Always reporting all taxable income sources
- Making sure you qualify for any credits/deductions claimed
- Checking for any new reporting requirements each year
The vast majority of taxpayers are honest and submit accurate returns. But unintentional errors or overly aggressive deductions do occasionally warrant the IRS’s attention. Keeping organized records, reporting all income, reviewing returns closely, and consulting experts for complicated tax situations can help identify and correct issues before they become serious problems.
Conclusion
In summary, common triggers for IRS trouble include claiming incorrect deductions or credits, failing to report all taxable income, making math errors that mismatch documents, repeatedly doing something questionable, improper reporting of business income/expenses, foreign transaction issues, and clear signs of intentional evasion or fraud. While IRS notices can happen inadvertently, taking care to avoid these red flags, maintain records, report all income, and file an accurate return can minimize audit risk. Consulting a tax pro or responding promptly to all IRS inquiries is important as well. With some care taken on your part, you can typically avoid making the kinds of mistakes that tend to get taxpayers in trouble with the IRS.