What Triggers a Tax Audit?

By Joy Taylor From Kiplinger’s Personal FinanceThe editor of The Kiplinger Tax Letter responds to readers asking about the chances the Internal Revenue Service (IRS) will take a closer look at their return.Question: Friends have told me that I don’t have to worry about IRS audits anymore. Are they right?Answer: No. It is true that major cuts to the IRS’ funding and its workforce will reduce the number of tax audits the agency can perform. In recent years, the IRS audit rate for individuals was significantly below 1 percent, and we expect this figure to continue to decline, at least over the next few years. But that doesn’t mean it’s a free-for-all for tax cheats. According to IRS leaders, there will be fewer overall audits, but the exams that are done will be more targeted.The IRS is relying on data analytics and artificial intelligence to more precisely identify high-risk noncompliance and to improve efficiency. Data-mining software can sift through taxpayer data, expose suspicious activity and identify audit cases.Question: I am a tax preparer, and many of my clients claim refundable tax credits on their federal returns, such as the earned income credit, the refundable portion of the child credit, the Affordable Care Act premium credit and the American Opportunity credit. I heard that the IRS will be eyeing these credits more than ever before. Do you think this is true?Answer: Yes. The IRS’ enforcement arm is feeling the brunt of the government’s funding cuts as well as recent employee resignations and layoffs. Many of the workers who retired or left the IRS were experienced agents and managers with deep knowledge of the tax law and the processes for conducting complex tax audits of individuals and businesses.We expect the IRS will go after low-hanging fruit, such as questionable refundable tax credits claimed on tax returns. Most of these audits are done through correspondence, meaning the taxpayer never meets with an IRS employee. They’re a bit more cost-effective, because the audit is generally limited to only one or two issues. The IRS also knows that a lot of money is lost each year to erroneous claims of refundable tax credits. The IRS estimated it improperly paid $21.4 billion in refundable credits in fiscal year 2024 alone.Question: What does the IRS consider in deciding whether to audit a taxpayer’s Form 1040?Answer: We don’t know the IRS’ exact formula for choosing returns to audit. That’s a closely held secret. But we are aware of various factors or red flags that could escalate one’s chance of selection in the unenviable audit lottery. In addition to claiming refundable credits, here are some other moves that may catch the IRS’ attention:Failing to report all taxable income. The IRS receives copies of all the 1099 and W-2 forms you receive, and IRS computers are pretty good at cross-checking the forms with the income shown on your return.Making a lot of money. While overall individual audit rates are extremely low, the odds increase significantly as your income goes up (especially if you have business income).Failing to file your income tax return. The primary emphasis is on individuals who received income in excess of $100,000 but didn’t file a tax return.Taking higher-than-average deductions, losses or credits. If the deductions, losses or credits on your return are disproportionately large compared with your income, the IRS may want to take a second look at your return. Taking a big loss from the sale of rental property or other investments can also pique the IRS’ curiosity.Taking large deductions for charitable contributions. If these deductions are disproportionately large compared with your income, it raises a red flag because the IRS knows what the average charitable donation is for folks at your income level. If you don’t get an appraisal for donations of valuable property, or if you fail to file IRS Form 8283 for noncash donations over $500, you’re even more likely to be targeted.Running a business. Schedule C of Form 1040 is a treasure trove of tax deductions for self-employed people. But it’s also a gold mine for IRS agents, who know from experience that self-employed people sometimes claim excessive deductions and don’t report all their income. Sole proprietors reporting at least $100,000 of gross receipts on Schedule C and cash-intensive businesses (taxis, car washes, bars, restaurants and the like) have a higher audit risk.Writing off a hobby loss. You’re a prime audit target if you report multiple years of losses on Schedule C, run an activity that sounds like a hobby and have lots of income from other sources.Failing to report self-employment income and pay self-employment taxes. Some limited partners and LLC members who don’t file Schedule SE or pay self-employment tax are on the IRS’ radar. The agency has an ongoing audit campaign involving the issue of when limited partners and LLC members in professional service industries owe self-employment tax on their distributive share of the firm’s income.Claiming rental losses. The IRS actively scrutinizes large rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. The agency is pulling returns of individuals who claim they are real estate professionals and whose W-2 forms or other non-real-estate Schedule C businesses show lots of income.Taking a distribution from an IRA or 401(k) before age 59½. The IRS wants to be sure that owners of traditional IRAs and participants in 401(k)s and other workplace retirement plans are properly reporting and paying tax on distributions.Failing to report gambling winnings or claiming big gambling losses. Recreational gamblers must report winnings as other income on the 1040 form. Professional gamblers show their winnings on Schedule C. Failure to report gambling winnings can draw IRS attention.Claiming the foreign earned income exclusion when working overseas. U.S. citizens who work overseas can exclude up to $132,900 of their income earned abroad on their 2026 tax return if they were bona fide residents of another country for the entire year or they were outside of the United States for at least 330 complete days in a 12-month span. IRS agents actively sniff out people who are erroneously taking this break.Engaging in transactions with virtual currency or other digital assets. The IRS is on the hunt for taxpayers who sell, receive, trade or otherwise deal in Bitcoin or other virtual currency or digital assets. As part of the IRS’ efforts to clamp down on unreported income from these transactions, revenue agents are mailing letters to people they believe have virtual currency accounts.Failing to report a foreign bank account. The IRS is intensely interested in people with money stashed outside the United States, especially in countries with the reputation of being tax havens, and U.S. authorities have had lots of success getting foreign banks to disclose account information. Failure to report a foreign bank account can lead to severe penalties.©2026 The Kiplinger Washington Editors, Inc. Distributed by Tribune Content Agency, LLC.The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. 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