5 Ways to Reduce Your Risk of an Income Tax Audit

No taxpayer wants to receive an audit notice from the IRS. While audits are relatively rare, certain red flags can increase the likelihood of scrutiny. Understanding these common triggers and taking proactive steps can help reduce your risk of an audit.

1. Report All Income Accurately

One of the easiest ways to attract IRS attention is failing to report all sources of income. Employers, banks, and investment firms submit income forms such as W-2s and 1099s directly to the IRS, and discrepancies between these records and your tax return can raise red flags.

How to avoid issues:

• Double-check that all income sources are included before filing.
• Keep records of freelance or gig work that may not have issued a 1099.
• Report cryptocurrency transactions, rental income, and any foreign earnings properly.

2. Be Cautious with Large Swings in Income

Significant changes in income from year to year can sometimes prompt IRS scrutiny, especially if there’s no clear explanation. While fluctuations are normal, drastic income drops or surges should be well-documented.

How to avoid issues:

• Maintain records that justify income changes, such as business expansions, job transitions, or major expenses.
• If claiming a major loss, be prepared to show supporting documents.

3. Handle Business Losses Properly

The IRS is particularly wary of businesses that repeatedly report losses. A business that operates at a loss for multiple years may be flagged as a hobby rather than a legitimate business, disqualifying it from certain deductions.

How to avoid issues:

• Ensure your business meets the IRS criteria for a for-profit enterprise.
• Keep detailed records of expenses, revenues, and business activities.
• If reporting losses, document efforts to make the business profitable.

4. Avoid Questionable Deductions

Claiming excessive or unusual deductions can raise suspicion, particularly if they appear disproportionate to your income level. This includes unusually high charitable donations, business expenses, or home office deductions.

How to avoid issues:

• Only claim deductions that are legitimate and well-documented.
• Ensure home office deductions meet strict IRS guidelines.
• Keep receipts and written explanations for any large or unusual deductions.

5. Properly Value Assets

When reporting capital gains, estate valuations, or inherited property, undervaluing assets can result in IRS scrutiny. The IRS compares reported values against market data, and discrepancies may trigger audits.

How to avoid issues:

• Use accurate appraisals for inherited or gifted property.
• Report fair market value on investments and real estate transactions.
• Consult a tax professional for guidance on asset valuations.

By staying diligent, keeping thorough records, and ensuring accuracy in your tax filings, you can significantly reduce the risk of an IRS audit. When in doubt, working with a qualified tax professional can provide additional peace of mind and help you stay compliant with tax laws.

As always, remember to schedule regular appointments with us as your financial situation changes. We can help you anticipate certain situations and plan ahead to avoid complications.