When the IRS notifies you of an audit, that sinking feeling in your stomach is perfectly normal. I’m Venar Ayar, and I’ve guided thousands of clients through this process. Let me assure you that preparation makes all the difference between a stressful ordeal and a manageable procedure.

The Internal Revenue Service conducts audits to verify the accuracy of your tax returns and ensure compliance with tax laws. While less than 1% of all returns are selected for audit, understanding what triggers them and how to prepare can save you significant stress, time, and potentially money.

The IRS has limited resources, so it strategically selects returns that present the highest probability of discrepancies or additional tax revenue. This selection process isn’t random—it’s calculated to maximize the efficiency of their enforcement efforts. Understanding this approach can help you minimize your audit risk while still claiming all legitimate deductions and credits to which you’re entitled.

Understanding Audit Triggers

While the IRS does randomly select some returns for audits, certain factors act as IRS audit triggers, significantly increasing your risk of being selected for an IRS audit. 

High Income Earners: Returns reporting over $500,000 face higher audit rates, and those climb even higher for those earning over $1 million. The IRS knows that examining high-income returns often yields greater tax adjustments, making these audits more cost-effective for its limited resources.

Self-Employment Income: Schedule C filers are subject to higher scrutiny, particularly those with cash-intensive businesses. The IRS acknowledges that self-employed taxpayers have a higher risk of underreporting income or overstating deductions compared to employees who receive W-2 forms.

Large Deductions Relative to Income: If your charitable contributions, business expenses, or home office deductions seem disproportionate to an individual taxpayer’s income, red flags go up. The IRS compares your itemized deductions to statistical norms for your income level, and significant deviations trigger questions.

Missing Income: The IRS receives copies of your W-2s, 1099s, and other income documents. Failing to report all income sources almost guarantees scrutiny. Their automated matching system easily identifies discrepancies between reported income and tax returns filed by payers.

Foreign Assets: Unreported foreign bank accounts or other foreign assets can trigger specialized audits, often with severe penalties. The Foreign Account Tax Compliance Act (FATCA) has dramatically increased the IRS’s visibility into offshore holdings.

Round Numbers: Filing a return with too many perfectly rounded numbers (such as $1,000 instead of $1,027) suggests estimation rather than accurate record-keeping. The IRS knows that legitimate expenses rarely result in perfectly round figures.

Cryptocurrency Transactions: With increased focus on digital assets, failing to report crypto gains has become a significant trigger. The IRS has invested heavily in tracking blockchain transactions and identifying taxpayers who are non-compliant.

Excessive Business Travel and Meals: These frequently abused deductions receive extra attention, especially when they represent a large percentage of business income. Maintaining detailed logs with business purposes for each expense is essential.

Early Withdrawals from Retirement Accounts: Taking money from IRAs or 401(k)s before age 59½ often triggers additional scrutiny to verify whether exceptions to the 10% penalty apply.

Hobby Losses: Reporting losses from activities that could be considered hobbies rather than legitimate businesses on tax returns raises red flags. 

Audit Rates and Trends

Everyone wants to know their chances of being audited. While overall audit rates have declined over the past decade due to IRS budget constraints, recent funding increases are changing this trend. The IRS has received additional resources for enforcement activities, with a significant portion directed toward compliance efforts.

Audit rates vary by income level, with higher-income taxpayers facing greater scrutiny. The IRS has publicly stated its intention to focus increased enforcement on high-income individuals, large corporations, and complex partnerships rather than ordinary wage earners.

My experience with clients across different income brackets confirms this focus. I’ve represented numerous high-income earners and business owners who faced intensive examinations, while their employees with simpler tax situations remained audit-free.

The Inflation Reduction Act of 2022 provided the IRS with significant additional funding, much of which is earmarked for enforcement. This means we can expect audit chances to increase in the coming years, particularly for taxpayers with complex returns or high incomes.

Steps for Preparing for an Audit

If you receive an audit notice, take these immediate steps:

1. Don’t panic. An audit notice doesn’t necessarily mean you’ve done something wrong. Many audits result in no changes or even refunds.
   
2. Note the response deadline. Missing deadlines can forfeit your rights to appeal or present evidence. IRS deadlines are rarely extended without good cause.
   
3. Identify what’s being audited. Most audits focus on specific items rather than your entire return. The notice will indicate which items or years are under examination.
   
4. Gather relevant documentation. Documentation includes receipts, invoices, canceled checks, loan agreements, travel logs, and any supporting evidence for the items under examination. Original documents are preferable to copies when possible.
   
5. Organize chronologically. Create a system that makes locating specific documents quick and easy. Consider creating summary sheets that link each deduction to its supporting documentation.
   
6. Review the questioned items. Understand why you claimed what you did and be prepared to explain your position. If you used a tax preparer, consult with them about the documentation they relied upon.
   
7. Consider professional representation. Tax attorneys provide attorney-client privilege protection that CPAs and enrolled agents cannot. This privilege can be crucial if potentially criminal issues arise during the audit.
   
8. Prepare a summary. Provide a clear explanation of each questioned item, accompanied by supporting documentation. Making the auditor’s job easier often results in a more favorable outcome.
   
9. Limit the scope. Provide documentation only for the specific items being audited. Volunteering additional information can expand the audit’s scope unnecessarily.
   
10. Practice your explanations. Be prepared to clearly articulate the business purpose for expenses and how they relate to your income-producing activities.
    

Never ignore an audit notice. The problem won’t disappear, and failing to respond typically results in the IRS making adjustments without your input, usually not in your favor.

Claiming Deductions and Credits

Deductions and credits offer legitimate tax savings, but claiming them properly requires careful documentation:

Business Expenses: For each expense, document what was purchased, when, from whom, for how much, and the business purpose. A contemporaneous log is far more convincing than a reconstruction created during an audit.

Charitable Contributions: For donations over $250, obtain a written acknowledgment from the charity. For non-cash donations exceeding $5,000, get a qualified appraisal. The IRS frequently challenges charitable deductions lacking proper substantiation.

Home Office Deduction: This legitimate deduction requires exclusive and regular use of the space for business. Measure the area accurately and maintain photos showing its dedicated business use. Consider using the simplified method ($5 per square foot up to 300 square feet) if documentation is challenging.

Vehicle Expenses: Keep a mileage log showing the date, destination, purpose, and miles driven for each business trip. Apps make this easier than paper logs. Remember that commuting between home and a regular workplace is not deductible.

Medical Expenses: Only medical expenses exceeding 7.5% of your adjusted gross income are deductible, making this threshold difficult for many taxpayers to reach.

Education Credits: The American Opportunity Credit and Lifetime Learning Credit require documentation of qualified education expenses. Maintain records of tuition statements (Form 1098-T) and receipts for required books and supplies.

Child and Dependent Care Credit: Document care provider information, including their tax ID number, along with receipts for payments made. The IRS can disallow this credit without proper substantiation.

Energy Efficiency Credits: For home improvements qualifying for energy credits, keep manufacturer certifications and receipts showing the improvements meet the specific requirements for the credit claimed.

Cash and Digital Transactions

Cash businesses face heightened scrutiny because of the potential for unreported income. If your business handles significant cash, implement these practices:

• Use a separate business bank account for all business transactions
• Make regular, documented deposits that reconcile with your sales records
• Keep a daily cash transaction log detailing all receipts and expenditures
• Reconcile your sales records with deposits to ensure all income is accounted for
• Consider a point-of-sale system that tracks all transactions electronically
• Maintain a clear audit trail connecting sales to deposits to tax returns
• Document cash payments to vendors or employees with receipts and proper payroll records
• Consider using numbered receipts for all cash transactions to demonstrate systematic recording

For cryptocurrency and digital assets, the IRS has intensified enforcement. Every transaction potentially triggers a taxable event. Specialized software can help track your cost basis and calculate gains or losses for tax purposes. The IRS now requires specific reporting of crypto transactions, though implementation timelines have been delayed. The infrastructure bill expanded reporting requirements for digital asset exchanges.

Foreign Accounts and Assets

Foreign financial accounts require specific reporting beyond your regular tax return. If you have foreign accounts totaling over $10,000 at any point during the year, you must file a Foreign Bank Account Report (FBAR) using FinCEN Form 114.

Additional reporting requirements apply to those with certain foreign assets through Form 8938 (Statement of Specified Foreign Financial Assets). The thresholds for this form vary based on filing status and whether you live in the US or abroad.

Penalties for failing to report foreign accounts are severe. They can reach $10,000 per violation for non-willful failures and potentially much higher for willful violations, plus criminal prosecution in extreme cases.

The IRS offers voluntary disclosure programs for taxpayers who have failed to report foreign accounts. These programs can significantly reduce penalties, but they must be utilized before the IRS initiates an examination.

I’ve seen clients face devastating consequences from innocent mistakes with foreign reporting. Don’t let this happen to you. The complexity of these requirements makes professional guidance particularly valuable in this area.

Audit Tax Returns

When preparing returns that might face audit scrutiny:

• File on time or obtain a proper extension to avoid late-filing penalties
• Double-check all math and transfers between forms to prevent computational errors
• Report all income shown on information returns (W-2s, 1099s) to avoid automatic matching discrepancies
• Attach all required schedules and forms to provide complete information
• Explain unusual items through attached statements rather than leaving them unexplained
• Keep copies of everything you file, including all supporting documentation
• Retain supporting documentation for at least three years, extended to six years if understatement has occurs and indefinitely in cases of suspected fraud. 
• Consider the timing of income and deductions to minimize audit risk
• Be consistent in how you report similar items from year to year
• If using tax preparation software, review the final return carefully before filing

If you’ve made errors on past returns, consider filing amended returns before potential issues are discovered. Taking the initiative to correct mistakes can sometimes result in better outcomes than waiting for problems to be identified during an examination.

Audit Report and Findings

After an audit, you’ll receive a report proposing either:

• No change: Your return is accepted as filed with no adjustments
• Agreed: Changes are proposed that you accept, resulting in additional tax, a refund, or no change in tax
• Disagreed: Changes are proposed that you dispute, requiring further resolution

If you agree with the findings, you’ll sign the examination report or a similar form. Payment arrangements can be made if you can’t immediately pay the additional tax. Options include installment agreements, offers in compromise, or temporarily delaying collection if you can demonstrate financial hardship.

If you disagree with the findings, you have several options:

• Request a meeting with the examiner’s manager to review disputed items
• Pursue mediation through available IRS dispute resolution programs like Fast Track Settlement
• Request an appeals conference with the IRS Office of Appeals
• File a petition in Tax Court (generally within 90 days of receiving a Notice of Deficiency)
• Pay the tax and file a claim for refund, potentially leading to litigation in the District Court or the Court of Federal Claims.

The appeals process can often result in a more favorable outcome than the initial audit determination. Appeals officers have greater settlement authority and focus on the hazards of litigation when evaluating disputed items.

Tips for Avoiding Future Audits

While no strategy guarantees audit-proof returns, these practices significantly reduce your risk:

• Report all income, even if you don’t receive a formal tax document like a 1099 or W-2
• Be precise with deductions and keep supporting documentation organized by category and year
• File electronically to reduce math errors and omissions that might trigger automated reviews
• Use a professional tax preparer with experience in your specific situation who stays current on tax law changes
• Explain unusual items through attached statements rather than leaving them unexplained for the IRS to question
• File on time or request proper extensions to avoid penalties and additional scrutiny
• If self-employed, maintain separate business and personal accounts to delineate business expenses clearly
• For cash-intensive businesses, use bank deposits to document income and maintain detailed records of all transactions
• Report foreign accounts and assets completely and in a timely manner to avoid severe penalties for non-compliance
• Review prior year audits for insights on risk areas specific to your tax situation
• Consider a tax professional review of returns with unusual or complex items before filing
• Be consistent in how you report income and deductions from year to year
• Document business purpose for travel, meals, and other deductible expenses contemporaneously
• Maintain a mileage log if claiming vehicle expenses for business use
• Keep receipts organized by deduction category to facilitate quick retrieval if questioned

Remember that honest, accurate reporting supported by good records is your best defense against audit problems. When the IRS knows you maintain thorough records and understand tax law, they’re less likely to invest significant resources in auditing your return.

If you do face an audit, getting professional representation from a qualified tax attorney can make a substantial difference in the outcome. I’ve seen firsthand how proper preparation and representation can transform a potentially devastating audit into a manageable process.

Don’t face the IRS alone. Request a free case evaluation today and let our team at Ayar Law help protect your finances, property, and peace of mind.