Audit Red Flags

First, what an audit usually is

The word brings to mind an agent at your kitchen table going through shoeboxes. That almost never happens. The great majority of IRS examinations are done entirely by mail: a letter arrives naming one or two items on your return, asks for the records behind them, and gives you a deadline. You send copies, and the IRS either accepts them or proposes a change. Field audits — the in-person kind — are reserved for complicated returns and businesses.

Even more common than an audit is a notice that is not technically an audit at all. The IRS receives a copy of every W-2, 1099 and 1098 issued in your name, and a computer compares them to your return. When something you were paid does not appear, a CP2000 letter arrives with a proposed bill. It feels like an audit. It is a matching letter, and it is the single most common piece of IRS mail a taxpayer ever gets.

How returns get picked

What tends to draw a second look

None of these mean you will be audited. Plenty of people claim every item below legitimately and never hear a word. They are the places where the IRS has learned, from experience, that mistakes and exaggeration cluster — which means they are the places where records matter most.

• Income that is on a form but not on the returnA forgotten brokerage account, an IRA distribution, a side job that sent a 1099, a 1099-K from an online platform. This is the number one source of IRS letters, and it is entirely avoidable: every form issued in your name goes on the return. If a form is wrong, the answer is to get the issuer to correct it, not to leave it off. See brokerage 1099s and Form 1099-K.
• The Earned Income CreditRefundable, worth thousands, and governed by complicated rules about who counts as a qualifying child. More returns claiming this credit are examined than any other category. The usual problem is a child who did not actually live with the taxpayer for more than half the year. The EITC.
• Education creditsThe American Opportunity Credit is claimed for a fifth year, without a Form 1098-T, or by both the parent and the student. Education credits.
• A Schedule C that loses money every yearA business is supposed to make a profit, at least some of the time. Losses in three or more years out of five invite the question of whether it is a business at all or a hobby with deductions. Business or hobby?
• Round numbers and personal expenses on a Schedule CExpenses ending in three zeros. Meals and travel well above what others in the same line of work report. A vehicle claimed at 100% business use when it is the only car in the household. A home office that is also the guest room. Each is a deduction the IRS knows is often inflated, so each is a place to keep a log. The home office.
• Cash businessesRestaurants, salons, contractors, anything where a lot of the money arrives as cash. The IRS has written examination guides for these industries and assumes some income goes unreported.
• Charitable deductions out of proportion to incomeGifts that are large for the income on the return, noncash donations of used goods valued generously, and anything over $5,000 without the appraisal the rules require. The deduction is fine; the paperwork has to be there. Charitable giving.
• Rental lossesRental real estate losses are limited for most people, and claiming to be a “real estate professional” to get around the limit while also holding a full-time job elsewhere is a known pattern. A vacation home that is both rented and used personally has its own set of rules. Vacation homes.
• Big swings in incomeMuch more than last year, or much less. The IRS keeps history, and a return that looks nothing like the one before it gets a look.
• High incomeReturns over $200,000 are examined at several times the overall rate, and returns over $1 million at many times. Not because of wrongdoing, but because there is more on them.
• Divorce mismatchesAlimony deducted by one ex-spouse and not reported by the other, child support deducted as if it were alimony, or both parents claiming the same child. The IRS matches these across both returns. Divorce and taxes and who should claim the child.
• Foreign accountsInterest in or signature authority over a bank account outside the United States brings separate reporting requirements with severe penalties for silence. The question is on Schedule B every year.
• The digital asset questionEvery return asks whether you dealt in cryptocurrency or other digital assets. Answering no when exchanges have reported otherwise is a mismatch like any other. Digital assets.
• Not filing at allIf you do not file, the IRS can build a return for you from the forms it has, with no deductions, no credits, and a bill. Unfiled and overdue returns.

What a careful return looks like

The one defense that works is an accurate return with the records behind it. In practice that means a few habits:

• Every form you receive goes on the return, even the small ones, even the ones you think are wrong. Wrong forms get corrected at the source.
• Deductions are claimed because you are entitled to them, not because they are available. The question we ask is not “will this get noticed” but “can this be shown.”
• Receipts, mileage logs, acknowledgment letters from charities, and appraisals are gathered when the money is spent, not reconstructed in April — or three years later when the letter comes.
• Letters from the IRS get opened and answered on time. The ones that cause real damage are the ones left in a drawer.

A return prepared that way can still be examined. It just will not have much to find.

If the IRS changes your federal return, Colorado follows

The IRS and the Colorado Department of Revenue share information. When a federal examination changes your income, Colorado expects an amended state return within 30 days, and will bill you itself if it does not get one. We handle both when a change comes through.