While the chances of an audit are slim, there are several reasons why your return may get flagged, triggering an IRS notice, tax experts say. Red flags may include excessive write-offs compared with income, unreported earnings, refundable tax credits and more.
You Spent or Deposited a Lot of Cash
Under the Bank Secrecy Act, various types of businesses are required to notify the IRS and other federal agencies whenever anyone engages in large cash transactions that involve more than $10,000.
Federal law requires a person to report cash transactions of more than $10,000 by filing IRS Form 8300PDF, Report of Cash Payments Over $10,000 Received in a Trade or Business.
Returns with extremely large deductions in relation to income are more likely to be audited. For example, if your tax return shows that you earn $25,000, you are more likely to be audited if you claim $20,000 in deductions than if you claim $2,000.
Audit trends vary by taxpayer income. In recent years, IRS audited taxpayers with incomes below $25,000 and those with incomes of $500,000 or more at higher-than-average rates. But, audit rates have dropped for all income levels—with audit rates decreasing the most for taxpayers with incomes of $200,000 or more.
The Short Answer: Yes. The IRS probably already knows about many of your financial accounts, and the IRS can get information on how much is there. But, in reality, the IRS rarely digs deeper into your bank and financial accounts unless you're being audited or the IRS is collecting back taxes from you.
Red flags: Failing to report all taxable income; taking low wages; overstating deductions; claiming high losses well above those in earlier years; not recording debt forgiveness; intermingling personal and business income and expenses; excessive travel and entertainment expenses; and amended returns.
“Double-check everything — Social Security numbers, your address, make sure all boxes are checked that need to be,” said Shannonhouse, at the AICPA. “All those things help prevent your return from getting flagged at the IRS.”
Foreign or "offshore" bank accounts are a popular place to hide both illegal and legally earned income. By law, any U.S. citizen with money in a foreign bank account must submit a document called a Report of Foreign Bank and Financial Accounts (FBAR) [source: IRS].
Does the IRS Catch All Mistakes? No, the IRS probably won't catch all mistakes. But it does run tax returns through a number of processes to catch math errors and odd income and expense reporting.
What is the chance of being audited by the IRS? The overall audit rate is extremely low, less than 1% of all tax returns get examined within a year.
Failing to report all of your income on your tax return is a top audit trigger. That's because income that goes unreported on your tax return also goes untaxed. The IRS receives copies of your W-2 and 1099 forms and will automatically check to see that your reported income matches up.
The IRS does check each and every tax return that is filed. If there are any discrepancies, you will be notified through the mail.
Information statement matching: The IRS receives copies of income-reporting statements (such as forms 1099, W-2, K-1, etc.) sent to you. It then uses automated computer programs to match this information to your individual tax return to ensure the income reported on these statements is reported on your tax return.
If the IRS has shortlisted you for an audit, then you will be informed of this through a written notification that will be sent to your last recorded address. The IRS usually doesn't notify you of an audit via phone or email, so be wary of any email that claims to be about an IRS audit.
This is most easily observed by looking at Tax Year 2019 which is presented in the FY 2021 Data Book with audit results as of September 30, 2021. Tax returns for 2019 are filed in 2020 and may be filed on extension as late as October 15, 2020.
The IRS generally includes returns filed within the past three years in an audit. However, if during the audit process the IRS identifies a substantial error, it may audit additional prior years. It is rare for the IRS to go back more than six years in an audit.
Since the time limit ends around tax time, the agency may issue many of its audit letters in the fall and winter of the year before the three-year window expires. However, the IRS sends out audit letters at any time of year.
The most common reason for the IRS to review a tax return is something called the Discriminant Function System (or DIF) score. The IRS uses a computerized scoring model that evaluates your return and gives it a score based on the likelihood that it will need to be changed.
During an IRS tax audit, the IRS looks at all of the subject's financial reporting and tax information and has the authority to request additional financial documents, such as receipts, reports, and statements.
The $10,000 Rule
Ever wondered how much cash deposit is suspicious? The Rule, as created by the Bank Secrecy Act, declares that any individual or business receiving more than $10 000 in a single or multiple cash transactions is legally obligated to report this to the Internal Revenue Service (IRS).
The Bank Secrecy Act is officially called the Currency and Foreign Transactions Reporting Act, started in 1970. It states that banks must report any deposits (and withdrawals, for that matter) that they receive over $10,000 to the Internal Revenue Service.
Depositing a big amount of cash that is $10,000 or more means your bank or credit union will report it to the federal government. The $10,000 threshold was created as part of the Bank Secrecy Act, passed by Congress in 1970, and adjusted with the Patriot Act in 2002.