8 Common IRS Tax Audit Triggers
The IRS has a bad reputation as an agency that seeks to squeeze more money out of taxpayers. But the truth is as long as you are reporting your income appropriately — taking only legitimate deductions and not doing anything shady — you’re unlikely to ever experience a tax audit on your personal or business taxes.
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The IRS tends to trigger audits within three years of filing your taxes, though some situations — particularly if something criminal is going on — can take place after three years, according to Wayne Bechtol, a senior tax accountant and board advisor with Fiona. The IRS can also go back further with your tax returns if they notice a significant error.
Finance and tax experts recommend being aware of the following IRS audit triggers and knowing what you can do to avoid making these mistakes.
Dealing in Cryptocurrency Transactions
The popular rise of digital asset transactions involving bitcoin, NFTs and other cryptocurrencies could trigger an audit, even if you haven’t made any money from selling your digital assets. According to Bechtol, “Return filers should indicate through Form 1040 whether they have engaged in a digital asset transaction. IRS tracks such transactions using data analytics and AI.”
You can avoid this mistake by tracking your transactions in the cryptocurrency space. Since a digital asset can substitute for currency when paying for goods and services or digital trades, you must answer accurately when your federal tax return inquires about digital assets.
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Mismatch in Returns Filed
If you think the IRS won’t notice a little discrepancy between what you report and the forms you receive, you’re mistaken. “The IRS receives a copy of all your income documents, including the W-2, Form 1099, K-1, and others,” Bechtol explained. “The amounts should match those included in your tax returns. A mismatch can invite an IRS tax audit.”
You can avoid this mistake by double-checking the income information you include in your return. The IRS compares your return with the documents that arrive as W-2s or 1099s from employers or banks. If any of the information doesn’t match then you should expect to receive a CP2000 notice.
Claiming Hobbies as Businesses
You can write off business expenses but not those from hobbies, Bechtol warned. “The IRS can distinguish between hobby and business expenses because any profit from a business not shown in three out of five years constitutes a hobby. Therefore, deductions for hobby expenses are limited.”
You can avoid this mistake by reviewing the distinctions between a hobby and a business. Any activity that’s done without the intention of profit is generally considered a hobby and not a business.
Excessive Deductions or Tax Credits
Claiming an excessive amount of deductions or tax credits can also raise suspicion and trigger an audit, said Sophia Jones, an investment analyst at PiggyBank. “It’s important to ensure that all deductions and credits claimed are accurately and legitimately reported.”
You can avoid this mistake by being careful about the tax credits you apply for. In 2022, the IRS issued almost 16 million math error notices due to several issues, with the recovery rebate and Child Tax Credit at the top of the list.
Claiming Business Losses
Some businesses don’t generate a profit immediately, which is understandable. However, too many consecutive years of business losses can trigger an audit from the IRS as they may consider this a hobby.
You can avoid this mistake by limiting how many years you claim your business losses since the IRS can eventually deem your venture a hobby if you don’t turn a profit.
Not Reporting Income From Side Hustles or Gig Work
Side hustles and gig work may be separate from your main salary, but they count as income, according to Miles Brooks, a director of tax strategy at CoinLedger. “The IRS requires taxpayers to report income from side jobs like selling products on Etsy. The tax authority demands that taxpayers should estimate the tax payments associated with gig work, including reporting self-employment taxes.”
The best way to avoid this mistake is to report all of your income, regardless of where it came from. The IRS expects to know about every income stream that exceeds $400.
Claiming Rent Expense for the Self-Employed
Another favorite audit trigger, according to CPA Wendy Barlin, is questioning a home office deduction when a professional also has rent expense on their corporation. “The law requires only a primary office be deducted as a home office deduction so when they also see rent expense, this will trigger a notice.”
You can avoid this mistake by ensuring correct information is reported, because there has been plenty of confusion over the home office tax claims.
Writing Off Excess Travel Expenses
Sometimes the line between business and leisure travel can be blurry, but be very careful about writing off anything that isn’t for business, Barlin warned. “In the last few years the IRS was aggressively targeting travel expenses as many business owners were going on beach vacations and deeming these deductible as ‘retreats.'”
In general, she recommends that taxpayers “be reasonable in their expenses as IRS law requires all business income tax deductible expenses to be ‘ordinary and necessary’ for the business.”
You can avoid this mistake by ensuring you don’t fall for common assumptions many individuals will make when it comes to travel expenses. For example, you can’t write off a family vacation just because you discussed some business. The IRS has clear guidelines for an “ordinary and necessary” business expense.
Closing Thoughts
Eric J. Nisall, accountant and founder of Understand Finances, shared insights if you’re worried about making a mistake that will trigger a tax audit:
“Anyone can get audited, even if you don’t hit any of these triggers. If you’re being truthful and accurate with the information you use to fill out your tax return you shouldn’t be afraid of an audit. Don’t let that fear stop you from claiming any tax deduction or credit that you legally qualify for and can substantiate.”
Jordan Rosenfeld contributed to the reporting in this article.
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