IRS Tax Cheat Detection: 3 Signs Your Tax Return Could Be Under Scrutiny
In the world of taxes, it's essential for taxpayers to be aware of the red flags that could potentially trigger an IRS audit. Here are some common areas that the IRS closely monitors:
Unreported Income
One of the most obvious red flags is unreported income. If the IRS has records of 1099 forms for freelance work, interest, crypto gains, or rental income, but you do not report that income, it often triggers a CP2000 notice and further scrutiny.
Deductions Disproportionately Large Compared to Income
Claiming very high deductions relative to your income, especially on Schedule C for self-employed individuals, raises suspicion. For instance, claiming $50K in deductions on $80K income could be a cause for concern.
Cryptocurrency Transactions Not Properly Reported
Failing to file Form 8949 for crypto trades or not checking the crypto box on the tax return can invite audits.
Repeated Business Losses
Reporting losses year after year on a business activity can lead the IRS to reclassify it as a hobby, disallowing deductions.
Cash-Heavy Businesses
Industries like restaurants, salons, and contractors that predominantly deal in cash face closer IRS scrutiny due to high risks of underreported income.
Home Office Deductions
Inaccurate or sloppy claims that don’t meet the IRS’s “exclusive and regular use” test can trigger audits.
Payroll Reporting Inaccuracies
Misreporting wages, tips, or withholdings, as well as misclassifying employees vs. contractors, can quickly attract IRS attention because of mismatched payroll filings.
These red flags often come to the IRS’s attention through automated data matching against third-party records, such as forms submitted by employers or financial institutions. IRS enforcement increasingly relies on algorithms and data analytics rather than direct mail or phone calls.
It's important to take IRS notices seriously and reply in a timely manner. The IRS is very concerned with catching people who cheat in some way when claiming the earned income tax credit (EITC). The IRS also scrutinizes the information reported on Schedule C, particularly high business expenses in relation to income, for potential instances of cheating.
The IRS uses a DIF score (for "discriminant function") to identify problematic returns, and the ratios are intentionally kept a secret to prevent people from gaming the system. In 2022, an estimated $514 billion in individual income taxes went unpaid, according to the most recent IRS data. The reporting threshold for 1099-NEC and 1099-MISC forms will be boosted to $2,000 starting in 2026, and the reporting threshold for 1099-K forms is now $20,000 plus 200 transactions.
Addressing these areas carefully when filing can reduce audit risk.
In the realm of business and finance, the IRS closely monitors unreported income from various sources such as freelance work, interest, crypto gains, or rental income, and failure to report these can lead to a CP2000 notice and further investigation. Claiming excessive deductions on Schedule C, particularly if they are disproportionately large compared to income, can also raise suspicions and potentially trigger an audit.
