The IRS can audit any taxpayer for any reason, but increased wealth and business success often bring a higher level of IRS scrutiny. For example, if you have a complex financial portfolio, own a business, or make high-value transactions, your audit risk may rise. That doesn’t mean you should avoid those things, though. Instead, your focus should be on proactively safeguarding your financial decisions and preparing for common triggers.
Here are the top IRS audit triggers to watch out for, along with how you can protect your financial interests. Take a breath. Then, take a look at these triggers and make any proactive adjustments you can as soon as possible. An audit doesn’t have to be frightening, especially when you’re well-prepared for it.
Top 7 Triggers for IRS Audits Among High-Income Taxpayers
1. Schedule C Businesses
If you’re a high-income sole proprietor, you may face scrutiny for unreported income or disproportionately large deductions (e.g., luxury travel or entertainment). The IRS typically flags businesses that are showing significant revenue but minimal profit because they’re suspicious of the level of deductions being taken. Your personal and business records will be requested in a Schedule C audit, so strong record-keeping is vital.
2. Substantial Interests in S Corporations
Another reason you could trigger an IRS audit is through a substantial stake in an S corporation. IRS audit triggers for S corps include distributions that appear inconsistent with reported income, overly aggressive write-offs, shareholder compensation issues, or misclassified expenses. It’s not wrong to have big distributions or a lot of write-offs, as long as you document them in case the IRS comes knocking.
3. Trusts and Estate Filings
High-value trusts and estates often get the IRS’ attention, and they’ll be looking for underreported income, improper valuations, or errors in asset transfers. Documentation is one of the key tax audit defense strategies since the IRS will examine your records closely.
4. Complex Investment Portfolios
As you build wealth, it’s common to diversify your holdings into stocks, real estate, private equity, and more. Doing that can trigger audits where the IRS is looking for misreported capital gains, dividend discrepancies, or offshore accounts they may be incorrectly lowering your tax liability.
5. Real Estate Transactions
High-value property sales, 1031 exchanges, and depreciation strategies are common audit triggers for real estate investors. If you’re investing in real estate, especially if you’re purchasing multiple properties or frequently buying and selling, make sure you keep meticulous records of every transaction.
6. Inconsistency in Income Reporting
Significant fluctuations in your reported income, especially large increases, can draw IRS scrutiny. This is often seen with high-income individuals who have income sources from various countries. The IRS also looks closely at foreign account reporting and income from foreign sources. Ensuring consistent, transparent income reporting and compliance with all foreign account reporting requirements is crucial.
7. Mismatching of Reporting
Discrepancies between what is reported to the IRS and what appears on your tax return can quickly trigger an audit. This often involves mismatches in income reported by employers, banks, or investment entities on forms like W-2s and 1099s versus what is declared on your tax return. Ensuring that all forms and reports align before filing is critical to avoid this audit trigger.
How High-Income Individuals Can Protect Their Financial Interests
Work with Elite Tax Professionals: While you can’t control whether you’re audited, you can focus on high-net-worth tax strategies that will make an audit easier and protect your interests during one. Engaging an experienced tax lawyer and an accountant with expertise in high-net-worth clients and business owners is an important step, as their knowledge ensures compliance and provides audit protection strategies.
Maintain Detailed Documentation: All business owners should keep clear records of expenses, receipts, and contracts for high-value transactions. If you don’t own a business but have a high net wealth from investments or other means, maintain records for your investment activity, trust distributions, and real estate depreciation to help move through the process if you’re audited.
Engage Legal Counsel When Necessary: Most often, a skilled accountant can manage your tax filings and audit responses effectively. However, if your audit situation escalates or there’s a potential for a criminal or fraud referral, that’s when you need to call someone like Kundra & Associates. Our legal expertise ensures that you have the defense necessary to navigate these complex issues.
Regular Tax Filing Reviews: One of the best high-net-worth tax strategies is to proactively audit your own filings to identify and correct potential discrepancies before the IRS does. It’s much easier to fix something your accountant found before it makes its way to the IRS.
Stay Ahead of IRS Trends: Working with professionals who monitor IRS enforcement patterns, such as evolving rules on S corporations or trust taxation, is another essential way to reduce your chances of an audit. When you know what the IRS might be changing or focusing on, you know what to look for in your own filings.
Quick Tips for How to Respond to an IRS Audit
Responding to an IRS audit swiftly is important, but you also need an organized, accurate response. When you work with an IRS tax attorney, they can ensure that documentation is properly and professionally prepared, which will reduce the chances of escalation.
Leveraging a tax attorney’s legal expertise can also give you tailored strategies to defend your case and protect your financial interests. Make sure you provide your attorney with everything they need to build your case, including evidence supporting deductions, business transactions, or trust distributions.
Work With a Tax Lawyer to Ease Audit Concerns
It’s not realistic to know all the audit triggers for IRS scrutiny, but understanding the most common ones and taking preemptive measures can help you safeguard your complex financial portfolio or business venture. When you need guidance with audits and other tax matters, contact us today at Kundra & Associates. We specialize in representing high-net-worth individuals and business owners in audits and tax matters across the globe, especially those in Maryland, Washington D.C., and Virginia. Reach out today—we can help you with tax audit defense strategies that can have you breathing easier again.
