Warning Signs That May Trigger a Tax Audit

No one wants an unexpected visit from an IRS auditor. Since the IRS can't audit every tax return, it follows specific guidelines to flag those that warrant closer examination.

Here are six factors that could increase your chances of being audited.

Higher Income, Higher Audit Risk

While the IRS audits less than 1% of all individual tax returns, the likelihood increases with income. For those earning between $1 million and $5 million, the audit rate jumps to 1.6%, and for incomes between $5 million and $10 million, it rises to 3.1%.

Unusual Deductions or Claims

The IRS uses a scoring system called the Discriminant Information Function to compare deductions, credits, and exemptions within specific income brackets. While the exact formula is undisclosed, returns that significantly deviate from the norm are more likely to attract attention.

A Business That Looks Like a Hobby

Reporting business losses year after year could raise red flags. To be considered a legitimate business rather than a hobby, the IRS generally expects a profit in at least three of the last five years.

Missing Income Reports

Employers and financial institutions report income directly to the IRS. If your tax return doesn’t match these records, it could lead to additional scrutiny.

Conflicting Tax Returns from Divorced Couples

When ex-spouses file separate tax returns, the IRS checks for discrepancies, such as alimony payments reported by one party but not claimed as income by the other.

Rental Loss Deductions

The IRS closely monitors deductions for rental property losses. Generally, losses can only be deducted if the taxpayer actively participates in managing the property (with limitations) or qualifies as a real estate professional who spends more than 50% of their working hours and at least 750 hours annually in the industry.

While these factors don’t guarantee an audit, they can increase the chances of one. If you have complex tax situations, working with a tax professional can help ensure compliance and minimize risks.