IRS Red Flags: What Triggers an Audit and How to Stay Clear

Ever wonder why the IRS sometimes seems to be watching your tax return a little too closely? It often comes down to specific patterns that raise red flags in their system. Understanding those triggers can save you from an audit nightmare and keep your finances on track.

What Counts as an IRS Red Flag?

IRS red flags are data points or filing behaviors that signal a higher chance of an audit. The agency uses automated scoring models that compare entries on your tax return against norms for similar taxpayers. When a number falls outside the expected range, the return is flagged for deeper review.

Below are the most common triggers, each backed by real‑world audit statistics from the IRS data released in 2023.

1. Income That Doesn’t Match Third‑Party Reports

The IRS receives copies of every Form W‑2 and most 1099 statements. If the total wages you report on Form 1040 differ from the sum of those forms, the system flags the discrepancy.

• Under‑reporting by just 5% can trigger a review; under‑reporting by 10% or more almost guarantees one.
• Freelancers often miss this because they receive multiple 1099‑NEC forms from different clients.

2. Unusually Large Deductions

Deduction categories that soar far above the average for your income bracket raise alarms. The most frequent culprits are:

• Charitable contributions that exceed 60% of adjusted gross income.
• Business expenses on Schedule C that are a high percentage of revenue.
• Home office deductions claimed without a dedicated space.

Even legitimate large deductions can attract a closer look if you lack proper documentation.

3. Claiming Losses Year After Year

Consistently reporting net losses on a business or hobby can suggest a “bad” activity rather than a profit‑making venture. The IRS uses the hobby loss rules to differentiate between genuine business pursuits and personal hobbies.

• Three consecutive years of losses on Schedule C is a classic red flag.
• Losses that exceed 25% of gross receipts raise suspicion.

4. Foreign Financial Activity

Holding money in overseas accounts without filing the required FBAR (Foreign Bank Account Report) or Form 8938 is a major trigger. The penalties for non‑compliance can reach up to $10,000 per missed filing, plus steep civil fines.

• Even a $5,000 foreign account must be reported if the aggregate balance exceeds $10,000 at any point during the year.
• Cryptocurrency held on foreign exchanges falls under the same reporting rules.

5. High‑Risk Tax Credits

Credits like the Earned Income Tax Credit (EITC) are designed for low‑income earners. Claiming the credit when your income profile doesn’t match the eligibility thresholds is a quick way to get flagged.

• Incorrect qualifying children counts lead to the highest audit rates among credit claims.
• Business energy credits claimed without supporting documentation also attract attention.

6. Inconsistent Filing History

Sudden changes in filing status-such as switching from single to head of household-without clear life‑event justification can raise eyebrows. The same goes for large swings in itemized deductions versus the standard deduction.

• Switching to itemized deductions for one year after taking the standard for several years merits a review.
• Marriage, divorce, and dependents added or removed should be explained in the return’s notes section.

Quick Checklist to Spot Potential Red Flags

• Cross‑check all W‑2 and 1099 amounts against your reported income.
• Document every large charitable donation (receipts, acknowledgment letters).
• Keep detailed logs for business expenses-date, purpose, amount.
• File FBAR and Form 8938 on time; retain foreign account statements.
• Validate eligibility for every credit claimed; keep worksheets.
• Maintain a consistent filing approach; note any life changes.

Key Takeaways

• Income mismatches with third‑party forms are the top audit trigger.
• Excessive deductions, especially charitable and business, flag returns.
• Repeated business losses often signal a hobby, not a profit‑making enterprise.
• Foreign accounts must be reported; failure leads to severe penalties.
• Proper documentation is the single most effective defense against an audit.

How the IRS Uses These Flags

Once a return is flagged, the IRS runs it through a secondary review. If the score exceeds a threshold, the case is assigned to an examiner who may request additional documentation or issue an audit notice. The process usually follows these steps:

1. Initial scoring: Automated algorithms compare each line item to national averages.
2. Risk tier assignment: Returns are placed in low, medium, or high‑risk buckets.
3. Human review: An examiner examines the flagged items, looking for patterns or inconsistencies.
4. Correspondence: If needed, the IRS sends a Letter 105 or a formal audit letter.
5. Resolution: You provide requested records; the examiner makes a determination.

Understanding the workflow helps you prepare the right paperwork before the IRS even contacts you.

Pro Tips to Keep Your Return Safe

• Use the IRS’s Interactive Tax Assistant while filing; it flags common errors in real time.
• Prefer electronic filing; the system validates numeric totals against attached forms automatically.
• Keep a digital folder with PDFs of every supporting document for at least seven years.
• When in doubt, attach a brief explanatory note to the return (e.g., “Charitable donation includes non‑cash items; receipts attached”).
• Consider a pre‑audit review from a CPA if your return contains multiple high‑risk items.

What to Do If You’re Flagged

First, stay calm. A flag doesn’t mean you’re automatically guilty; it merely signals the IRS wants more information. Follow these steps:

1. Read the correspondence carefully; note any deadlines.
2. Gather every document the IRS requests-pay stubs, bank statements, receipts.
3. Organize the files chronologically; label each with the relevant line item.
4. If the request is vague, call the provided number for clarification.
5. Consider hiring a tax professional, especially if the audit scope is broad.
6. Respond within the timeframe; extensions are possible but must be requested in writing.

Most audits resolve with a simple adjustment or a confirmation that everything is correct. Only a small fraction result in penalties.