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How to Reduce Your Risk of Getting Audited by the IRS

Avoid these red flags on your tax returns

tax audit stamp on US tax form 1040

iStock / Getty Images

En español | The odds are pretty low that the Internal Revenue Service (IRS) will audit your tax return. But why take a chance? If you know the red flags that make the taxman raise his eyebrows, you can reduce the already remote possibility that he'll take a closer look at your 1040.

The IRS audited more than 771,095 tax individual returns filed during the 2019 calendar year, according to Jackson Hewitt Tax Service. That's less than 0.5 percent of the 154.1 million individual returns filed that year. Audits aren't always painful, either. Some result in refunds.  

Most audits are conducted by mail: The IRS spots something it suspects is wrong and sends a letter explaining the problem or asking for additional information. (The IRS never starts an audit by phone; if someone calls you and threatens an audit, it's a scam.) The IRS conducts about 26 percent of its audits of individual returns in person.

Even though the odds of an audit are extremely low, most people would prefer not to undergo one. Here are some of the most common reasons the IRS selects returns to audit:

Basic blunders

The IRS does indeed check your math. It also gets copies of your tax forms from employers, banks and other financial institutions. You’ll also get a notice (Form 1099-G) from your state if you’ve collected unemployment benefits, which are taxable. If you don't add up your income correctly, or if you put the wrong amount from a W-2 form, you'll hear from the agency. You'll also hear from the IRS if you neglect to include a W-2, 1099 or some other tax notice from a third party. “It's the most common notice that goes out,” says IRS Director of Examination Scott Irick.

Technically, these notices aren't audits, but they are one surefire way to get your tax return kicked back. Don't ignore them.

Incidentally, if you’ve sold cryptocurrency for profit, those gains are subject to capital gains taxes. The IRS is using data analytics to track compliance, so don’t think your trading activity has gone entirely unnoticed.

Lots of money

Taxpayers with incomes of $10 million or more have substantially higher audit rates than taxpayers with lower incomes: In 2018, the IRS audited 8.1 percent of those returns. It makes sense for the IRS to go for the high-income returns in part because those returns tend to be the most complex — and more prone to errors.

Not surprisingly, people with incomes of less than $25,000 have a much lower risk than millionaires of being audited. If you have little income and do get audited, you can find a Low Income Taxpayer Clinic, which can represent you before the IRS or in court on audits, appeals and other tax disputes. Services are provided free or for a small fee.

Throughout tax season, check for the latest updates and resources  

Large deductions

You may be tempted to goose up the size of your deductions, but if you get carried away, you could cook your own goose. Some people really do give half their income to charity, for example, but those people are rare — and probably rare enough to prompt an inquiry from the IRS.

Similarly, the IRS looks at average business deductions by type of work to tag dodgy deductions. If your small-business deductions are significantly higher — say, 20 percent higher — than the average in your profession, the IRS could ask you to provide proof of your expenses. If you know you're going to have an unusually large deduction, such as for mileage, for example, make sure you keep good records.

The IRS does audit some returns randomly. It uses the information it gets to adjust its computerized monitoring programs. If your return has been selected randomly for an audit, you may have done nothing at all to warrant it. “We're always refining our filters,” Irick says.

Your business is really a hobby

If you own a small business, you can deduct the cost of many things that you use to produce income. If you're a woodworker and you sell cutting boards, for example, you can deduct the cost of saws, sandpaper and wood. If you just like to make cutting boards as a hobby in retirement, you can't deduct any of your woodworking expenses.

One of the tests the IRS makes for deciding whether you have a business or a hobby is whether you've made any money. Claim three consecutive years of business losses (or three years out of five), and the IRS could suspect that you have a money-losing hobby, not a money-losing business.

To test whether your business really is a business, the IRS will want to know whether you keep complete and accurate records, whether you depend on the income for your livelihood and whether your losses were beyond your control. You can read the full list of considerations at Bear in mind that the IRS will make decisions about businesses on a case-by-case basis.

You claim the Earned Income Tax Credit (EITC)

The EITC is for low and moderate-income taxpayers and can reduce your tax burden dollar-for-dollar. It can even give you a refund of more than you paid in income tax. Not surprisingly, people often try to take the EITC illegally – and not surprisingly, the IRS takes a very close look at returns that claim the EITC.