The Internal Revenue Service (IRS) is responsible for making sure individuals and businesses pay the correct amount of taxes. Every tax year, they enforce tax compliance by reviewing income tax returns and flagging anything that looks inaccurate, inconsistent, or suspicious. Even if the mistake was unintentional, it can trigger audits, penalties, or further investigation.
This is why you must understand what raises audit red flags. It will help you avoid common filing mistakes that lead to unwanted IRS attention. Whether it’s unreported income, unusually high deductions, or errors on your return, knowing these risks puts you in a better position to stay compliant and protect your finances.
Worried about an IRS audit or notice? Victory Tax Lawyers can help you resolve it fast with experienced, direct legal representation. Contact us today for a free consultation.
In this guide, you’ll learn the key IRS red flags that trigger audits, how returns are selected for review, what happens if you’re flagged, and how to avoid penalties. income tax return
What Raises Red Flags With the IRS?
The IRS looks for certain patterns and mistakes that commonly lead to audits or further review. These “red flags” signal potential errors, exaggerations, or omissions on a tax return, even if unintentional. These red flags that could trigger an audit include:
1. Large, Unexplained Deductions or Losses
Claiming unusually large tax breaks like tax deductions on your tax return can easily attract unwanted attention from the IRS. When your losses appear excessive compared to your reported income, it raises immediate red flags. The IRS pays close attention to deductions that seem out of step with what’s typical for your profession or industry, or that significantly differ from your previous tax filings. It’s worse if these deductions can’t be explained or backed up with clear records. You could face an audit, additional tax assessments, and potentially costly penalties.
2. Excessive Business Expenses
If you’ve claimed business expenses on your tax return, you know it can lower your taxable income. But claiming too much or listing personal expenses as business deductions can quickly attract IRS attention. Whether it’s unusually high travel expenses or entertainment costs that don’t make sense for your business, the IRS can challenge your deductions.
3. Frequent Amendments or Changes to Tax Returns
Filing an amended tax return is perfectly legal. Mistakes happen. You could forget to report income, miss a deduction, or correct a simple math error. However, when you file frequent amendments year after year or make significant changes multiple times in a short period, it can raise red flags with the IRS. Repeated amendments may lead to questions and IRS audits.
4. Cash-Intensive Businesses and Underreported Income
If you run a business that deals mostly in cash, like a restaurant, salon, car wash, or small retail store, you’re more likely to get attention from the IRS. That’s because cash-heavy businesses have a higher risk of underreporting income, whether intentionally or by mistake. The IRS keeps a close eye on these types of businesses and uses advanced methods to spot irregularities.
5. Round Numbers and Mathematical Errors
One common red flag is the use of too many round numbers in reporting expenses. An example is documenting $5,000 or $10,000 without supporting receipts. This often signals a lack of proper documentation or potential exaggeration of deductions.
Mathematical errors also raise suspicions. Simple mistakes in calculation can prompt the IRS.
6. High Income With Low Reported Tax
If you earn a high income but report unusually low tax payments, it’s likely to raise red flags with the IRS. The IRS closely monitors tax returns where reported taxes seem out of line with gross income.
7. Claiming Dependents or Credits Incorrectly
Claiming dependents or tax credits on your tax return can lower how much you owe or even get you a refund, but making mistakes here can quickly cause tax problems. The IRS pays close attention to dependent claims and popular credits like the Child Tax Credit (CTC) and the Earned Income Tax Credit (EITC). If you make a wrong claim, you could face penalties.
8. Failure to Report Foreign Accounts or Income
If you have foreign bank accounts or earn income overseas, you are legally required to report these to the IRS. Failing to report foreign assets can lead to steep penalties under laws like the Foreign Account Tax Compliance Act (FATCA).
9. Reporting Losses Year After Year
If your business reports losses year after year, it’s natural to wonder if the IRS might take a closer look. While every business faces ups and downs, consistently claiming losses on your tax return can trigger concerns about whether your operation is a legitimate business or not. The IRS uses specific rules to determine if your losses are allowable, and ignoring those rules can lead to audits, penalties, or even reclassification of your business activities.
10. Misclassifying Employees as Contractors
One of the most common IRS red flags is misclassifying workers as independent contractors when they should be employees. The difference between 1099 contractors and W-2 employees comes down to control. If you control how, when, and where the person works, they’re likely an employee.
You will get serious penalties for misclassification. The IRS may also require you to reclassify workers correctly going forward.
11. Filing Late or Not Filing at All
Many taxpayers underestimate how serious it can be to file a tax return late or skip filing altogether. Don’t skip filing your tax returns. The IRS doesn’t take it lightly.
12. Home Office Deduction Misuse
The home office deduction is a legitimate way to reduce your tax bill. But it’s also a common source of IRS red flags. To qualify, you must use part of your home regularly and exclusively for business purposes. Occasional use or mixing personal and business activities in the same space doesn’t count.
Many taxpayers get flagged for claiming excessive expenses, deducting personal space, or inflating the percentage of their home used for business. These mistakes can trigger audits and lead to disallowed deductions, penalties, and interest.
13. Unusually High Charitable Contributions
Charitable donations are tax-deductible. But claiming unusually large charitable contributions that are high compared to your income is a quick way to get flagged by the IRS. The IRS compares your donations to national averages for your income bracket and scrutinizes returns that stand out.
To avoid issues, you must have proper documentation for any donation over $250 and formal appraisals for non-cash donations of significant value. Overstating donations or failing to provide proof during an audit can lead to disallowed deductions, additional taxes, and penalties.
If your charitable giving is legitimate but large, be prepared to show clear, organized records to support your claim.
How the IRS Detects Red Flags
The IRS uses advanced systems to identify tax returns that might require further review. One key tool is the Discriminant Information Function (DIF) score. This is an internal system that analyzes your return against statistical norms. A high DIF score signals that something on your return stands out.
The IRS also relies heavily on third-party reporting to track wages, investments, and financial interest such as dividends or foreign accounts. Employers, banks, and other institutions submit tax documents like W-2s and 1099s directly to the IRS. If your reported income doesn’t match what these third parties report, it raises an immediate red flag.
Not all audits are triggered by red flags. Some are random audits. However, targeted audits, driven by discrepancies or suspicious activity, are more common and typically carry a higher risk of additional scrutiny and penalties.
What Happens When the IRS Flags Your Return
When the IRS flags your return, it doesn’t automatically mean you’re in trouble. Your return will attract close review, though. The IRS will send you a notice explaining what triggered the flag and what information they need from you.
The audit process begins with a letter from the IRS. The letter outlines specific areas of concern. You’ll be asked to provide documentation or explanations for certain deductions, income, or credits. How you respond can determine whether the issue is resolved quickly or escalates to more serious consequences.
The IRS uses different types of audits depending on the severity of the red flags:
- Correspondence Audit: This audit is the most common and least invasive. The IRS requests specific documentation via mail to verify certain parts of your return.
- Office Audit: You’re asked to visit an IRS office with relevant records to clarify deductions, income, or expenses.
- Field Audit: This audit involves an IRS agent visiting your home or business to perform a full review of your financial records. Field audits often occur when the IRS suspects substantial underreporting of income or other tax-related issues.
Audits can lead to additional taxes, interest, and penalties. In severe cases, penalties can reach up to 75% of the underpaid tax if fraud is suspected. Prolonged disputes or ignored notices can also lead to liens, levies, or wage garnishments.
At Victory Tax Lawyers, we help you avoid the worst-case scenario. Our experienced tax attorneys manage every step of the audit process, deal directly with the IRS, and work to minimize what you owe. We offer flat-rate pricing with no hidden fees, so you know exactly what to expect with no surprises.
What to Do if You Are Flagged or Audited
Getting an IRS notice can be intimidating. Nonetheless, how you respond can make all the difference. These are the steps to responding to the IRS:
- Read the Notice Carefully: The IRS letter will outline exactly what’s being questioned. It could be income, deductions, or missing forms. You don’t want to ignore it, as ignoring notices can lead to penalties, enforced collections, and even a federal tax lien.
- Gather Documentation: Start collecting receipts, bank statements, tax records, and any documentation related to the flagged issues. Solid documentation can help you resolve the situation faster and reduce or eliminate penalties.
- Check for Deadlines: The IRS always provides a deadline for response. Missing it can escalate your case or increase your back taxes with penalties and interest.
How to Respond Effectively
When dealing with the IRS, how you respond matters just as much as when you respond. A clear, respectful, and timely reply can help resolve your issue faster and avoid unnecessary complications. To respond effectively, you should:
- Be prompt. Don’t let notices pile up.
- Be accurate. Only provide clear, relevant documentation.
- Be professional. Courteous communication with the IRS improves your case outcome.
That said, not every IRS letter is simple to handle on your own. If your case involves complex tax issues, large back taxes, or prior audits, responding without expert guidance can actually make things worse. In these cases, you absolutely need professional help.
Not sure if you need a CPA or a tax attorney? Here’s a quick guide:
- CPA (Certified Public Accountant): Best for simple audits, bookkeeping issues, or help with amended returns.
- Tax Attorney: Ideal for back taxes, audits with potential legal exposure, complex disputes, or when facing enforced collection actions like federal tax liens.
At Victory Tax Lawyers, our licensed tax attorneys are trained to resolve cases that CPAs can’t handle, especially audits, disputes, and negotiations with the IRS.
How to Avoid Raising Red Flags With the IRS
While there’s no way to guarantee you’ll never be audited, you can reduce your risk by filing clean, accurate returns and avoiding common mistakes.
1. Be Accurate and Honest with Tax Reporting
Always report all sources of income and avoid inflating deductions or credits. Double-check numbers before you file, especially if you have freelance or investment income, as these are common audit triggers. You want to calculate your tax liability correctly to avoid underpayment penalties. Make sure you only claim eligible dependents and correctly calculate credits like the Child Tax Credit, as these areas are closely monitored by the IRS.
2. Keep Detailed Documentation and Receipts
Good record-keeping is your best defense if the IRS ever questions your return. Keep receipts, mileage logs, donation letters, and any relevant paperwork organized and ready to support your claims. Always separate personal expenses from legitimate business costs to avoid unnecessary IRS scrutiny.
3. Work With a Tax Professional
If your taxes are complicated, working with a CPA or tax attorney can help you avoid costly errors. Professionals stay updated on tax laws and know how to prepare returns that don’t raise unnecessary red flags.
Taking these simple steps can help you avoid audits, prevent disputes, and give you peace of mind at tax time.
Don’t Face the IRS Alone — We’ve Got Your Back!
Avoiding trouble with the IRS starts with understanding common red flags like inaccurate income reporting, questionable deductions, and inconsistent filings. Staying compliant and transparent with your taxes is the simplest way to reduce your risk of audits and penalties.
Worried about an audit or IRS trouble? Speak directly to a licensed tax attorney at Victory Tax Lawyers today. Get your free consultation now.
FAQs
If you’re worried about IRS red flags or wondering how audits really work, you’re not alone. Below are answers to some of the most common questions taxpayers have about IRS audits and investigations.
1. What Triggers an IRS Investigation?
An IRS investigation is typically triggered by significant discrepancies in your tax return, underreported income, large unverified deductions, or suspected fraud. The IRS also investigates cases flagged by third-party reporting
2. How Do You Know if the IRS Flagged You?
You’ll receive an official notice by mail from the IRS. This letter outlines what part of your return is under review and what information you need to provide. The IRS does not initiate audits or investigations by phone, email, or text.
3. Can a Small Mistake Trigger an IRS Audit?
Yes, even minor errors like math mistakes or forgetting a small 1099 can lead to questions from the IRS. While not every small mistake results in a full audit, it can still prompt additional scrutiny or correction notices.
4. How Often Does the IRS Audit Taxpayers?
IRS audit rates vary, but in recent years, less than 1% of individual tax returns have been audited. However, the chances increase with high-income earners, large deductions, or business returns with unusual activity.
5. Are Some Taxpayers More Likely to Be Audited?
Yes. Taxpayers with self-employment income, large deductions relative to income, foreign assets, or prior audit history are more likely to face audits. High earners and certain industries also see increased audit rates.
6. What Are the Most Common Reasons for IRS Audits?
Common triggers include unreported income, excessive business expenses, mismatched third-party reports, home office deductions, and high charitable contributions without proper documentation.
