25 Tax Audit Flags

by Ron Haynes

Tax audit. Just the words instill fear in the average taxpayer. A tax return is flagged for an IRS audit only about one percent of the time, and although that may not sound like a lot, getting selected for an IRS tax audit can be a time consuming and costly affair … even if you did nothing wrong. There’s the time away from your job, the worry, and if things go really wrong … an IRS tax attorney or worse … a tax relief attorney!

The key to avoiding the audit flag

Your best bet to avoid an IRS audit is to be as average as possible. Nothing out of the ordinary, nothing that would raise an alarm, nothing that looks fishy. In other words, be honest and if you DO have something unusual going on with your tax return, be prepared to substantiate it with proper documentation.

What are the flags that can trigger an audit?

audit-flagsCertain entries on a tax form have historically indicated the potential for tax fraud and the IRS knows them backwards and forwards. If you have any of these types of income or deductions, just know in advance that you’re in the company of people who may get audited:

1. High Income

Just making more money that the average person is an audit flag in itself. Make between $200,000 and $1 million, you’re chances rise from 1.1 to 2.7 percent. Make over a million and you’re about eight times more likely than the average individual to get audited. Merry Christmas.

2. Sloppy handwriting

With more and more people using TurboTax or H&R Block Online this isn’t the problem it used to be, but if you do prepare your return by hand, make certain your handwriting is neat and readable.

3. Home-office deduction

Statistically speaking, enough people who claim the home office deduction don’t actually qualify for it. The rules surrounding this deduction are extremely  intricate and difficult to follow … and they must be followed to the letter.

4. Under-reported income

Companies report the income they pay to individuals using a W-4 or a 1099 your reported income is supposed to match it. If it doesn’t, your returned could be flagged for an audit.

5. State reported income doesn’t match federal reported income

There is an expectation that the income you report on your state return will match the income reported on your federal return. Discrepancies are usually the result of an error, so that leads to questions about the accuracy of your overall return. Guess where that can lead?

6. Drastic income changes

Granted, many people have lost their jobs and have experienced drastic changes in their income but if you’ve maintained employment and still have a large shift in income, the IRS will probably want to know why.

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7. Income from a job plus a Schedule C with a loss

If you’re working full time and report income on a W-2 plus have a side business or hobby that loses money (reported on Schedule C), get ready for some questions. This is a strong audit flag.

8. Deductions for unreimbursed employee business expenses

If you weren’t reimbursed for things like business meals and entertainment, you’re a favorite target for an IRS audit. Why? Too many people have exaggerated these expenses in the past so it’s a natural audit flag. When times are tough, people try to find as many deductions as they can and the temptation is there to exaggerate, but if you can substantiate it, don’t hesitate to claim it.

9. Far too many charitable contributions

If the average charitable deduction in your income range is $1,500 but you claim $10,000, your return will probably be flagged for an audit.

10. Big round numbers

Agents rarely see big round numbers so claiming exactly $2,000 in charitable deductions will probably get your return flagged for an audit.

11. Income from offshore accounts

We should all be so lucky. If you had income from an offshore account or venture, you’re still required to report it to the IRS. If you don’t, you could be subject to penalties and interest, but just having offshore income could flag your return for an audit.

12. Capital-gain exclusion on a home sale

In spite of the downturn in the housing market, if you bought a home many years ago and sold it last year, you may find that you still had a significant gain. And chances are good you made a few improvements which would increase your basis cost in the home. When this basis is increased, it makes it more probable that your gain falls within the capital gains exclusion. Changes to the basis cost of your home is low hanging fruit for tax cheats and the IRS knows it. The solution to this audit flag is to make certain you can substantiate the basis change. Keep good records!

13. Missing information

If something is missing on your return, the computer that scans it will kick it out for review. The last thing you want is to have an agent going over your return with a fine toothed comb so make certain all the required information is on your return or supporting documents you send the IRS.

14. Sole proprietorships

You can reduce your chances of an audit by incorporating your business or forming an LLC (try using the free incorporation services by Rocket Lawyer). By incorporating, you give your business a sense of legitimacy with the IRS and you may be able to avoid those audit flags.

15. Strangely low income

Ever wonder why you’re asked what your profession is on the bottom of your return? If you list income that is abnormally low for your profession, you’re likely to be flagged for an audit. Anesthesiologists usually make more than $25,000/yr and the IRS knows it.

16. Off the chart itemized deductions

Again, you’re expected to fit within a certain profile. If you make $50,000 but have $58,000 in itemized deductions, that isn’t normal! If those are legitimate deductions, by all means, take them, but know up front you may trigger and audit flag.

17. Losses on rental property

Especially now, with the housing market collapse and more people renting, claiming a loss on rental property may be abnormal. These losses are subject to whether you’re an active or passive landlord so get some tax advice from a professional if you do have losses on a rental property.

18. Loose lips sink ships

People WILL turn you in if they hear you bragging about sticking it to the IRS. That isn’t an audit flag, that an audit guarantee.

19. Inconsistencies

They can be as simple as a name change due to marriage or as complex as a carry back of net operating losses that took this year’s income down to zero. Either way, inconsistencies stand out and the IRS will take note.

20. Large casualty losses

The guidelines surrounding a casualty loss claim on your tax return are very specific, so be sure your loss qualifies before claiming it. Keep good records, take photographs and video, and keep any newspaper clippings.

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21. Too many dependents

You can only support just SO many people, so make certain you’re not claiming someone on YOUR return that i also being claimed on another.

22. Claiming the Earned Income Tax Credit (EITC)

The requirements for the EITC are complicated and many honest people make mistakes thinking they qualify when they don’t. Add in those who fraudulently try to increase the credit’s payout and you have an instant audit flag.

23. Claiming 100% business use of vehicle

Yeah, right. You NEVER use this vehicle for personal reasons? This is red meat for a tax auditor, especially if you have no other vehicle available for your own use.

24. Cash businesses

Own a restaurant, gas station, house painting business, flea market shop, or hair salons? You’re automatically flagged for suspicion because of the cash nature of your business.

25. Engaging in large currency transactions

IRS inspectors know that large currency transactions over $10,000 are a valuable source of audit leads for sniffing out unreported income. So if you make large cash purchases or deposits, be prepared for IRS scrutiny. Also, know that banks and other institutions are legally required to file reports on cash transactions over $10,000 or on ANY suspicious currently transaction (such as persons depositing $9,950 in cash one day and an additional $9,950 in cash two days later and another $9,950 the next day).

Bottom Line

Tell the truth, fill out your tax return honestly. If you have a legitimate deduction that’s listed in this article as an audit flag and you have the supporting documents to prove it, go ahead and take it. If you have income or losses that are legitimate and you have the supporting documents to prove them, go ahead and report them. After all, tax filers should only worry about an audit if they are cheating on their taxes.

Photo by gemma.amor

About the author

Ron Haynes has written 1001 articles on The Wisdom Journal.


The founder and editor of The Wisdom Journal in 2007, Ron has worked in banking, distribution, retail, and upper management for companies ranging in size from small startups to multi-billion dollar corporations. He graduated Suma Cum Laude from a top MBA program and currently is a Human Resources and Management consultant, helping companies know how employees will behave in varying situations and what motivates them to action, assisting firms in identifying top talent, and coaching managers and employees on how to better communicate and make the workplace MUCH more enjoyable. If you'd like help in these areas, contact Ron using the contact form at the top of this page or at 870-761-7881.


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