What Triggers an IRS Audit? Common Red Flags to Avoid

There's a specific kind of dread that comes with an envelope from the IRS. Your stomach drops before you even open it and see what they want. And if you see that they’re auditing you, the panic can set in quickly.

But it doesn’t have to.

While some IRS audits can be random, there are plenty that stem from the same handful of red flags. There's no reason why you shouldn't take steps to avoid committing these faux pas.

In this blog, we’re outlining:

• The red flags that can lead to an IRS audit

• Why certain taxpayers are more at risk

• How to reduce your risk of a tax audit

How Common Is an IRS Audit?

Per the IRS Data Book, the individual audit rate sits around 0.4 to 0.5%, so…not exactly high. However, audit rates climb significantly with higher income, more complex business operations, or if you’re self-employed.

You can also increase your risk of an IRS audit if you commit certain mistakes.

Top Red Flags That Can Trigger an IRS Audit

1. Unreported or Mismatched Income

W2's, 1099s, brokerage statements, and now crypto account broker forms are all reported directly to the IRS. They use an Automated Underreporter (AUR) program to cross-check every return against third-party data automatically, so no human review is needed to trigger an audit.

 You may trigger an audit for this reason if you: 

• Forgot to report side-gig income and about an old or dormant brokerage account

• Missed a freelance 1099-NEC document

• Received distributions from a 529 plan

2. Disproportionately Large Deductions

The IRS uses Discriminant Information Function (DIF) scoring to compare each return’s deductions to statistical norms for similar income levels. A charitable deduction, home office write-off, or business loss that's unusually large relative to your income raises that DIF score and pushes the return into manual review.

 As long as you're able to provide legitimate proof for your deductions, you should be able to claim them without problem. That's why it's important to keep receipts, quantify non-cash gifts, and build a paper trail for each deduction you claim.

3. Round or Estimated Numbers

Returns with suspiciously “neat” figures like $5,000, $10,000, or $25,000 across multiple lines read as estimates rather than pulled-from-records numbers.  Those stand out against the exact third-party figures the IRS already holds.

To avoid triggering an audit for this reason, report the exact dollar amounts, down to the cents if you have them, even if the difference is only a few dollars.

4. Cash-Intensive or Schedule C Businesses

Restaurants, salons, contractors, and other cash-heavy businesses are DIF outliers. That's especially the case when expense ratios significantly deviate from IRS industry benchmarks for that business type.

Even if you receive a significant portion of your income in cash, report it and keep funds in separate business and personal accounts. Be sure you claim expense ratios that are reasonably relative to the revenue you report.

5. Home Office & Vehicle Deductions

Claiming 100% business use of a vehicle or home office deduction without a space used exclusively and regularly for business are two of the most commonly disallowed (and flagged) deductions on individual tax returns.

If you use a vehicle for business, maintain a detailed mileage log, and potentially be conservative on the business use percentage claimed. 

6. Cryptocurrency & Digital Asset Activity

New documentation requires you to answer a direct yes or no digital asset question and gives the IRS the same visibility into your crypto transactions that it has had into your stock trades.

Don't risk an audit. Report every disposal, exchange, or crypto-for-goods transaction you make, not just what you cash out to your bank account.

7. Consistent, Multi-Year Business Losses

Sure, you can have a bad year or two, but several consecutive years of Schedule C losses can trigger a “hobby loss” review. This is when the IRS questions whether the activity is a genuine for-profit business.

Make sure you document your profit motive, including your business plan, marketing efforts, and hours worked, especially if you’re an early-stage or seasonal business.

While any taxpayer or business owner can trigger an IRS audit, you may be more at risk depending on where you live or operate a business

Why Long Island & Tri-State Filers Should Pay Extra Attention

Taxpayers in New York, New Jersey, and Connecticut need to be extra diligent in avoiding IRS audit red flags because of:

Dual Exposure

NY, NJ, and CT each run independent state tax enforcement. Most state tax departments (including NY's) maintain dedicated audit offices in or around NYC specifically to enforce local compliance. A federal flag and a state flag can happen independently, or one can trigger the other.

Multi-State Complexity

Remote work across state lines, out-of-state rental properties, or a business with a multi-state footprint all add filing complexity. That complexity itself can lead to higher audit odds.

Still, there is plenty you can do to avoid triggering an audit.

How to Reduce Your Audit Risk

To avoid receiving that terrifying IRS audit notice:

•  Report every income source, even the small, irregular, or one-time payments

•  Keep up-to-date documentation that matches every tax deduction you claim

•  Report exact figures instead of rounded estimates

•  file electronically to reduce math-error flags

•  Have a CPA sanity check your records and deductions before filing

Audit-Proof Your Return First with AVM DeMars

Whether you've already received a notice or just want peace of mind before you file, AVM DeMars is your trusted team of tax advocates across New York, New Jersey, and Connecticut. 

Our team has represented individuals and businesses in IRS and state tax examinations for years and can help you have peace of mind to avoid or safely make it through an audit.

Contact our team for a consultation today.