The chances of being audited by the IRS are generally low, with less than 1% of individual and corporate tax returns audited each year. However, certain factors can significantly increase the likelihood of an audit.
For individual taxpayers, the IRS audited an average of 0.44% of returns between 2013 and 2021, but this percentage isn’t evenly distributed across all taxpayers. Individuals with more straightforward tax returns, such as W-2 wage earners, typically face a lower chance of audit. Conversely, those with complex tax situations are more likely to be scrutinized. Key factors that can elevate the risk of an IRS audit include:
High Income
High-income earners are more likely to be audited. The IRS tends to focus its auditing resources on taxpayers in higher income brackets, as the potential for uncovering underreported income or other tax issues increases with wealth. For example, taxpayers reporting incomes over $400,000 have historically faced a much higher audit rate.
Claiming Refundable Credits
Refundable tax credits, especially the Earned Income Tax Credit (EITC), often attract attention. The IRS scrutinizes claims for these credits to ensure eligibility. Errors or fraudulent claims involving refundable credits can trigger an audit.
Self-Employment or Cash-Based Businesses
Self-employed individuals and those running cash-based businesses are at higher risk of audit, primarily due to the possibility of underreported income or inflated deductions with cash transactions. Taxpayers who receive a significant portion of their income from tips, freelance work, or side businesses—often not reported through traditional W-2 forms—may be audited if there is a large discrepancy between reported income and expenses or industry norms.
Unreported or Discrepant Income
The IRS uses a variety of tools to detect unreported income, such as matching information returns (e.g., 1099s or W-2s reported by the employer) against the income reported on your tax return. If there are discrepancies—such as income not reported or large differences from year to year—this can prompt an audit. Failure to report substantial investment income, cryptocurrency transactions, or foreign bank accounts can also draw attention.
Large Deductions or Unusual Expenses
Tax returns with deductions or expenses that appear disproportionately large compared to reported income may trigger a red flag. This is typically seen in unusually high business expenses that do not match the industry of the business. The IRS can examine the lifestyle or expenses of the individual taxpayer in comparison to the expenses they report. If the IRS sees large expenses that do not match income or industry standards, the IRS may audit these returns to ensure that the deductions are valid and substantiated.
While the average taxpayer has a low chance of being audited, certain red flags such as high income, refundable credits, self-employment, unreported income, or disproportionate deductions increase your audit risk.
