Filing taxes comes with inherent anxiety about triggering an IRS audit. While statistically, the odds of being audited by the IRS remain below 1% for most taxpayers, certain financial behaviors and reporting patterns can dramatically increase your IRS audit chance. Understanding these red flags is crucial for anyone looking to file confidently while minimizing unwanted scrutiny from tax authorities.
The IRS has significantly enhanced its enforcement capabilities in recent years through advanced data analytics and increased funding. While the agency claims it won’t target taxpayers earning under $400,000, the reality is that any return containing certain suspicious elements may face examination. This comprehensive guide explores 18 major audit triggers in exhaustive detail, providing actionable insights to help you navigate tax season safely.
Your IRS audit chance depends on multiple factors including income level, deduction patterns, and financial complexity. High-income earners, business owners, and those with international assets face the highest scrutiny, but even middle-class taxpayers can trigger audits through simple reporting errors. By understanding what catches the IRS’s attention, you can take proactive steps to file accurately while maximizing legitimate deductions.
1. Unreported or Underreported Income: The IRS Already Knows
One of the most common ways taxpayers inadvertently increase their odds of being audited by the IRS is by failing to report all taxable income. The IRS receives copies of every W-2, 1099, and other income documentation through its Information Returns Processing (IRP) system. When your filed return doesn’t match these third-party reports, it creates an immediate discrepancy that often triggers an automated notice or full audit.
The IRS audit chance increases substantially for taxpayers who omit income from:
- Freelance work or gig economy platforms (Uber, DoorDash, Etsy)
- Rental property earnings
- Investment income (dividends, interest, capital gains)
- Cryptocurrency transactions
- Foreign bank accounts
- Cash payments for services
Many taxpayers mistakenly believe small income streams don’t require reporting, but the IRS requires disclosure of all taxable income regardless of amount. Payment apps like Venmo and PayPal now issue 1099-K forms for transactions exceeding $600, meaning the IRS has greater visibility than ever into previously “invisible” income.
To minimize your odds of being audited by the IRS for unreported income:
- Cross-check all 1099s and W-2s against your records
- Maintain detailed records of side income
- Report all income streams, even if under $600
- Be aware of new cryptocurrency reporting requirements
- Keep business and personal accounts separate
The consequences of unreported income range from simple penalty notices to full-scale audits, especially if the IRS suspects willful evasion. In fiscal year 2022 alone, the IRS identified over $30 billion in unreported income through document matching programs.
2. High Income Earners Face Greater Scrutiny
Your IRS audit chance increases exponentially as your income rises. Recent IRS statistics show that taxpayers earning over $1 million face audit rates nearly 10 times higher than middle-class filers. This increased scrutiny stems from both the potential for larger tax adjustments and the complexity of high-net-worth returns.
The IRS has explicitly stated that enforcement efforts will prioritize:
- Individuals reporting over $400,000 in annual income
- Complex returns with multiple income streams
- Taxpayers with significant investment activity
- Business owners filing Schedule C or partnership returns
- Those claiming unusual deductions relative to income
For ultra-high-net-worth individuals, the odds of being audited by the IRS can exceed 10%, particularly if they:
- Utilize advanced tax strategies like conservation easements
- Maintain offshore assets or accounts
- Claim large business losses
- Have inconsistent year-to-year income reporting
The IRS’s “High Wealth Audit Group” specializes in examining wealthy taxpayers through comprehensive reviews that go beyond the 1040 to analyze related entities, trusts, and financial instruments. These audits often span multiple years and require extensive documentation.
To reduce your IRS audit chance as a high earner:
- Ensure all income sources are properly documented
- Maintain clear paper trails for large deductions
- Avoid aggressive tax positions without professional advice
- Be consistent in reporting methods year-to-year
- Consider pre-filing disclosure for uncertain positions
While the IRS claims it won’t increase audit rates for those earning under $400,000, the reality is that any return containing red flags may face examination regardless of income level.
3. The Dangers of Not Filing a Return
Failing to file a tax return significantly increases your odds of being audited by the IRS, especially if information documents (W-2s, 1099s) have been submitted under your Social Security number. The IRS’s Automated Substitute for Return (ASFR) program generates assessments for non-filers based on third-party information, often resulting in higher tax bills than if you had filed properly.
The IRS audit chance for non-filers is particularly high for:
- Individuals with income over $100,000
- Business owners who skip quarterly estimated payments
- Those with foreign financial accounts
- Recipients of significant investment income
- Taxpayers with previous filing compliance issues
Penalties for failure to file can be severe:
- 5% monthly penalty on unpaid taxes (max 25%)
- Additional 0.5% monthly failure-to-pay penalty
- Potential criminal charges for willful evasion
- Loss of refund claims after 3 years
- Levies on bank accounts and wages
The IRS has recently intensified its focus on high-income non-filers through:
- Special compliance initiatives targeting missing returns
- Automated matching of financial data
- Coordination with state tax authorities
- Information sharing through international agreements
To reduce your IRS audit chance if you’ve missed filings:
- File delinquent returns as soon as possible
- Consider the Streamlined Filing Compliance Procedures for offshore issues
- Consult a tax professional about penalty abatement options
- Stay current with all future filing requirements
- Respond promptly to any IRS notices
The IRS’s Non-Filer Program has identified billions in unpaid taxes from individuals who failed to file returns. In 2023 alone, the agency recovered over $500 million from non-filer enforcement actions.
4. Excessive Deductions Relative to Income
Claiming deductions that appear disproportionate to your reported income is one of the surest ways to increase your odds of being audited by the IRS. The agency’s discriminant index function (DIF) system flags returns where deductions exceed statistical norms for similar income levels.
Your IRS audit chance rises significantly if you report:
- Business losses year after year
- Charitable contributions exceeding 60% of AGI
- Home office deductions without proper documentation
- Unusually high medical expenses
- Excessive business vehicle use claims
The IRS maintains detailed benchmarks for average deductions by:
- Income bracket
- Profession/industry
- Geographic location
- Filing status
For example, claiming 50,000incharitabledeductionsona50,000incharitabledeductionsona100,000 salary would immediately raise red flags, as would reporting consistent Schedule C losses while maintaining an affluent lifestyle.
To minimize your IRS audit chance when claiming deductions:
- Ensure all write-offs have proper documentation
- Compare your deductions to industry averages
- Avoid round numbers that suggest estimation
- Maintain logs for business use of home/vehicle
- Be prepared to justify unusual deductions
The IRS particularly scrutinizes:
- Cash charitable contributions without receipts
- Large casualty loss claims
- Excessive business entertainment expenses
- Home office deductions in high-income returns
- Medical expenses barely exceeding the 7.5% threshold
If your deductions are legitimate but unusually high, consider attaching explanatory statements to your return preemptively addressing potential questions. This proactive approach can sometimes prevent an audit from being initiated.
5. Large Charitable Contributions Without Proper Documentation
Claiming substantial charitable donations is another factor that can increase your odds of being audited by the IRS, especially if the amounts appear disproportionate to your income or lack proper substantiation. The IRS maintains detailed databases of typical giving patterns and aggressively pursues questionable deductions.
Your IRS audit chance rises when claiming:
- Noncash donations exceeding $500 without Form 8283
- Gifts of property valued over $5,000 without appraisal
- Conservation easements (highly scrutinized)
- Donor-advised fund contributions
- Fractional interest gifts of artwork or collectibles
The IRS pays particular attention to:
- Sudden spikes in charitable giving
- Contributions representing large percentages of income
- Noncash donations of hard-to-value items
- Donations to unfamiliar organizations
- Gifts of appreciated property
Required documentation varies by donation amount:
- Under $250: Bank record or written acknowledgment
- 250−250−500: Written acknowledgment from charity
- $500+: Form 8283 for noncash gifts
- $5,000+: Qualified appraisal for certain property
- $50,000+: Detailed appraisal summary
To reduce your IRS audit chance for charitable deductions:
- Obtain contemporaneous written acknowledgments
- Use qualified appraisers for property donations
- Photograph noncash items donated
- Maintain records of how valuations were determined
- Avoid “overvaluation” of donated property
The IRS has won numerous cases involving inflated charitable deductions, particularly for:
- Overvalued vehicle donations
- Improperly appraised artwork
- Abusive conservation easements
- Misclassified personal property as charitable gifts
If you’re making substantial charitable gifts, consider consulting a tax professional to ensure full compliance with increasingly complex substantiation requirements. Proper documentation is your best defense if the IRS questions your deductions.
6. Self-Employment and Schedule C Audit Risks
Self-employed individuals and small business owners face significantly higher odds of being audited by the IRS compared to W-2 employees. Schedule C filers represent a disproportionate share of audited returns due to the potential for underreported income and overstated deductions.
Your IRS audit chance increases if you:
- Report over $100,000 in gross receipts
- Claim 100% business use of a vehicle
- Show consistent losses year after year
- Have cash-intensive businesses (restaurants, salons, etc.)
- Take large home office deductions
The IRS pays special attention to:
- Business expenses that seem personal in nature
- Round numbers suggesting estimation rather than actual amounts
- Deductions disproportionate to income
- Sudden changes in reported profit margins
- Returns mixing business and personal expenses
Common problem areas include:
- Vehicle expenses without mileage logs
- Meals and entertainment without business purpose documentation
- Home office deductions for occasional use spaces
- Excessive “other expenses” categories
- Unsubstantiated travel expenses
To reduce your IRS audit chance as a self-employed taxpayer:
- Maintain separate business bank accounts
- Keep detailed mileage logs with dates/purposes
- Retain receipts for all deductible expenses
- Document business purpose for questionable expenses
- Use accounting software to track income/expenses
- Avoid mixing personal and business funds
The IRS has sophisticated tools to detect questionable Schedule C filings, including:
- Industry-specific income/expense ratios
- Cash transaction analysis
- Comparison to similar businesses in your area
- Matching against information returns (1099s, etc.)
If you’re self-employed, investing in proper record-keeping systems and potentially working with a tax professional can pay dividends by reducing audit risk while ensuring you claim all legitimate deductions.
7. Hobby Losses vs. Legitimate Business Deductions
The distinction between a hobby and a business is a frequent audit trigger that can significantly increase your odds of being audited by the IRS. The agency closely examines activities that generate consistent losses, particularly when taxpayers have other substantial income sources.
Your IRS audit chance rises if you:
- Report losses from an activity for 3+ consecutive years
- Have significant income from other sources
- Participate in the activity irregularly
- Lack business licenses or professional credentials
- Don’t maintain proper business records
The IRS applies a nine-factor test to determine profit motive:
- Whether you carry out activity in businesslike manner
- Expertise of taxpayer or advisors
- Time and effort expended
- Expectation that assets may appreciate
- Success in similar activities
- History of income/losses
- Amount of occasional profits
- Financial status of taxpayer
- Elements of personal pleasure/recreation
The “3-of-5” year rule creates a presumption of profit motive if you show a net profit in any 3 of 5 consecutive years (2 of 7 for horse breeding). However, this is only a presumption – the IRS can still challenge activities that meet this test but appear hobby-like.
To reduce your IRS audit chance for activity losses:
- Maintain separate business bank accounts
- Develop a formal business plan
- Keep detailed records of time spent
- Document efforts to improve profitability
- Obtain necessary business licenses
- Track income/expenses using accounting software
If your activity is legitimate but hasn’t yet turned profitable, consider attaching a statement explaining your profit strategy and progress. This can sometimes preempt IRS questions about your deductions.
The IRS wins most hobby loss cases that go to court, so proper documentation is essential if you’re deducting losses from an activity that could be viewed as recreational rather than commercial.
8. Misclassified Self-Employment Income: A Growing IRS Target
The IRS has dramatically increased scrutiny of self-employment income classification, directly impacting your odds of being audited by the IRS. This issue particularly affects LLC members, limited partners, and gig workers who may incorrectly avoid paying self-employment taxes. The IRS audit chance spikes when filers attempt to characterize earned income as passive investment income to evade the 15.3% self-employment tax.
Recent court cases have established important precedents that increase your IRS audit chance:
- Hedge fund managers (Tax Court 2023): Active participants must pay SE tax regardless of LP status
- Law firm LLC members (Tax Court 2022): Professional service providers cannot claim passive treatment
- Real estate investors (Tax Court 2021): Material participation triggers SE tax obligations
The IRS uses several indicators to identify misclassification:
- 1099-MISC/1099-NEC forms showing significant income without Schedule SE
- Schedule K-1 filings with guaranteed payments to active participants
- Social media profiles or websites demonstrating active business involvement
- State business licenses requiring personal participation
To reduce your IRS audit chance regarding self-employment taxes:
- Properly document your role in any business entity
- File Schedule SE if you actively participate in operations
- Review LLC operating agreements for guaranteed payment clauses
- Maintain time logs proving passive vs. active involvement
- Consult a tax professional when structuring business entities
The IRS’s Self-Employment Tax Compliance Initiative has recovered over $900 million in unpaid taxes since 2020, primarily from:
- Doctors and lawyers in LLCs
- Hedge fund and private equity partners
- Real estate professionals
- Gig economy workers with multiple 1099s
9. Rental Real Estate Losses: Passive Activity Rules
Claiming rental real estate losses improperly will substantially increase your odds of being audited by the IRS. The IRS audit chance escalates when taxpayers attempt to deduct rental losses against other income without meeting strict passive activity rules. The IRS maintains specialized audit teams focused exclusively on real estate tax compliance.
Critical thresholds affecting your IRS audit chance:
- **25,000allowance∗∗:Maximumlossdeductionforactiveparticipants(phasesoutat25,000allowance∗∗:Maximumlossdeductionforactiveparticipants(phasesoutat100,000 AGI)
- 750-hour rule: Requirement for real estate professional status
- Material participation tests: 7 IRS criteria for proving active involvement
Red flags that trigger audits:
- White-collar professionals (doctors, lawyers) claiming RE pro status
- Schedule E losses exceeding $100,000
- Full-time employees suddenly becoming “real estate professionals”
- Lack of contemporaneous time tracking records
Documentation requirements to reduce audit risk:
- Daily time logs with specific property management activities
- Calendar entries showing hours spent on each property
- Property management contracts proving third-party involvement
- Bank records documenting expense payments
The IRS Real Estate Audit Technique Guide reveals their focus areas:
- Verification of 750+ hours across all properties
- Comparison to primary occupation time commitments
- Analysis of property management company usage
- Review of advertising and tenant screening processes
Recent audit statistics show:
- 72% of real estate professional audits result in adjustments
- Average additional tax assessed: $28,500 per audit
- Most common disallowed deductions: Travel, depreciation, and repairs
10. Questionable Refundable Tax Credits
Claiming refundable tax credits incorrectly will dramatically increase your odds of being audited by the IRS. The IRS audit chance approaches 80% for certain credits like the Earned Income Tax Credit (EITC), making proper documentation essential.
High-risk credits that increase IRS audit chance:
| Credit | Improper Payment Rate | Key Audit Triggers |
|---|---|---|
| EITC | 33% | Qualifying child tests, income limits |
| ACTC | 28% | SSN validity, relationship tests |
| AOTC | 22% | Enrollment status, 4-year limit |
| PTC | 19% | Marketplace documentation, income reconciliation |
EITC-specific audit triggers:
- Children not meeting residency requirements
- Income above threshold amounts
- Invalid Social Security numbers
- Claiming a child already claimed elsewhere
American Opportunity Credit red flags:
- Claiming for more than 4 tax years per student
- Missing Form 1098-T from educational institution
- No documentation of qualified expenses
- Claiming for ineligible students (graduate programs)
Premium Tax Credit compliance issues:
- Failure to reconcile advance payments
- Household income above 400% poverty level
- Incorrect family size reporting
- Lack of Marketplace insurance documentation
Documentation strategies to reduce audit risk:
- School enrollment verification for education credits
- Medical insurance forms for PTC reconciliation
- Birth certificates for child-based credits
- Full-year residency proof for EITC qualifying children
The IRS Automated Underreporter Program flags over 5 million credit claims annually, with nearly $14 billion in improper payments identified in 2023 alone. Taxpayers claiming these credits should be prepared for potential review and maintain all supporting documents for at least 6 years.
11. Early Retirement Account Withdrawals
Taking early distributions from retirement accounts significantly increases your odds of being audited by the IRS. The IRS audit chance spikes when taxpayers withdraw funds before age 59½ without properly documenting exceptions to the 10% penalty. IRS compliance programs specifically target retirement account distributions.
Most heavily scrutinized early withdrawals:
- Substantially equal periodic payments (72(t) plans) with calculation errors
- First-time homebuyer distributions exceeding $10,000
- Medical expense withdrawals without corresponding bills
- Higher education payments without enrollment verification
Documentation requirements:
- Form 5329 must be filed to claim exceptions
- Proof of qualified expenses for education/medical withdrawals
- Actuarial calculations for 72(t) payment plans
- Home purchase contracts for first-time buyer exceptions
Recent enforcement statistics:
- 2.8 million taxpayers made early withdrawals in 2022
- $1.3 billion in penalties assessed
- Audit rate for large early distributions: 3.2% (vs. 0.4% overall)
Red flags increasing IRS audit chance:
- Multiple early withdrawals in same tax year
- Distributions followed by large purchases (boats, vacations)
- No corresponding Form 5329 filed
- History of early withdrawals
Strategies to reduce audit risk:
- Directly pay institutions for qualified expenses
- Maintain paper trails linking withdrawals to allowed purposes
- Consult tax professionals before taking distributions
- Consider alternatives like loans before early withdrawals
The IRS Retirement Plan Compliance Unit uses sophisticated tracking systems to identify questionable distributions, making proper documentation essential for anyone needing early access to retirement funds.
12. Alimony Deduction Errors
Incorrectly claiming alimony deductions will increase your odds of being audited by the IRS. The IRS audit chance escalates when divorce agreements don’t meet strict tax law requirements or when ex-spouses file inconsistent returns. The IRS has implemented new matching programs specifically targeting alimony reporting.
Critical timing rules affecting deductibility:
- Pre-2019 agreements: Deductible if meeting all requirements
- Post-2018 agreements: Never deductible under TCJA changes
- Modified agreements: Must explicitly adopt new tax treatment
Audit triggers for alimony deductions:
- Missing ex-spouse’s Social Security number
- No divorce/separation instrument attached
- Payments continuing after recipient’s death
- Contradictory reporting between ex-spouses
Required documentation:
- Written divorce decree specifying alimony
- Payment records (cancelled checks, bank statements)
- SSN verification of recipient
- Termination clauses regarding death/remarriage
Recent enforcement data:
- 34% mismatch rate in alimony reporting
- $240 million in adjustments from 2022 audits
- Average additional tax assessed: $6,800 per case
Strategies to reduce audit risk:
- File Form 1040 Schedule 1 with recipient’s SSN
- Ensure decree language complies with tax law
- Coordinate reporting with ex-spouse
- Maintain payment records for 7+ years
The IRS Alimony Audit Technique Guide reveals their focus on:
- Cash payments without documentation
- Property settlements mischaracterized as alimony
- Child support payments incorrectly deducted
- Agreements modified after 2018 without proper language
Taxpayers claiming alimony deductions should be prepared for potential review, especially if payments are substantial or recently modified. Proper documentation is the best defense against audit adjustments.
13. Gambling Winnings and Losses: A High-Stakes Audit Trigger
Failing to properly report gambling income is one of the fastest ways to increase your odds of being audited by the IRS. The IRS audit chance skyrockets when taxpayers either omit casino winnings or exaggerate losses, as gaming establishments electronically report all significant payouts directly to tax authorities.
Key thresholds that trigger IRS scrutiny:
- Slot machine jackpots of $1,200+ (reported on W-2G)
- Table game wins of $5,000+ (reported for tournaments)
- Sports betting net wins of $600+ with 300+ times odds
- Poker tournament winnings exceeding $5,000
Documentation requirements to reduce audit risk:
- Maintain detailed win/loss statements from all gambling venues
- Keep original tickets and wagering records for sports betting
- Document session records showing dates/locations of play
- Obtain casino player card statements showing annual activity
Common audit triggers:
- Claiming large losses without corresponding W-2G forms
- Reporting net losses instead of gross winnings
- Failing to itemize deductions while claiming gambling losses
- Inconsistent reporting between state and federal returns
Professional gambler considerations:
- Must report on Schedule C with ordinary income rates
- Can deduct legitimate business expenses
- Subject to self-employment taxes
- Must prove profit motive and regularity of play
The IRS Gambling Audit Technique Guide reveals their examination focus:
- Comparing W-2G forms to reported income
- Verifying loss deductions don’t exceed winnings
- Checking for personal expense deductions disguised as gambling losses
- Reviewing bank records for unreported withdrawals at gaming venues
14. Foreign Earned Income Exclusion Mistakes
Claiming the Foreign Earned Income Exclusion (FEIE) improperly will substantially increase your odds of being audited by the IRS. The IRS audit chance for expatriate returns is nearly triple the national average, as the IRS has dedicated international exam teams scrutinizing these filings.
Critical requirements for FEIE qualification:
- Bona fide residence test: Full tax year in foreign country
- Physical presence test: 330+ days abroad in 12-month period
- Tax home requirement: Work base must be overseas
- Income limitations: $126,500 maximum exclusion (2024)
Red flags that trigger audits:
- Maintaining a U.S. home while claiming exclusion
- Frequent return trips to the United States
- Working for U.S. government or military overseas
- Failing to file Form 2555 with proper documentation
Documentation strategies:
- Passport stamps proving physical presence
- Foreign lease agreements or property deeds
- Local tax filings in host country
- Employer verification letters confirming work location
Recent enforcement trends:
- Increased coordination with foreign tax authorities
- Social media monitoring for evidence of U.S. presence
- Focus on “digital nomads” working remotely abroad
- Scrutiny of COVID-era work location claims
The IRS International Individual Compliance Program has collected over $1.2 billion in additional taxes from expat audits in the past three years, making proper documentation essential for anyone claiming the FEIE.
15. Marijuana Business Deductions: A High-Risk Industry
Operating a cannabis business dramatically increases your odds of being audited by the IRS, with the agency examining over 75% of returns from this industry. The IRS audit chance remains exceptionally high due to Internal Revenue Code Section 280E, which prohibits standard business deductions for drug trafficking organizations.
Current tax treatment of marijuana businesses:
- Allowed deductions: Cost of goods sold (COGS) only
- Prohibited expenses: Rent, utilities, payroll, marketing
- Tax rates: Effective rates often exceed 70% of net income
- Audit focus: Proper COGS calculations and inventory tracking
Pending regulatory changes:
- Potential reclassification to Schedule III drug
- Possible allowance of ordinary business expenses
- Banking access implications
- Impact on state tax conformity
Audit red flags:
- Claiming standard business deductions
- Unusually high COGS percentages
- Cash transaction reporting inconsistencies
- Personal expenses mixed with business accounts
Compliance strategies:
- Maintain meticulous inventory records
- Implement robust point-of-sale systems
- Separate personal and business finances completely
- Consider IRS Code Section 471 cost accounting methods
- Prepare for 100% documentation requests during audits
The IRS Marijuana Industry Compliance Program has collected over $300 million in additional taxes from cannabis business audits since 2018, making professional tax guidance essential for operators in this high-risk sector.
16. Research and Development (R&D) Tax Credit Claims
Aggressively claiming the R&D tax credit can significantly increase your odds of being audited by the IRS. The IRS audit chance for returns claiming this credit is approximately 5 times higher than average, as the IRS battles widespread abuse by both businesses and unethical tax preparers.
Four-part test for qualified research:
- Permitted purpose: New or improved function/performance
- Technical uncertainty: Technological information unknown
- Process of experimentation: Systematic trial-and-error
- Technological in nature: Hard sciences principles
Common audit triggers:
- Claiming credit for routine business activities
- Including ineligible personnel costs
- Failing to properly document research activities
- Claiming the credit without Form 6765
- Aggressive allocation methods for qualified expenses
Documentation best practices:
- Project lists with technical challenges
- Payroll records showing researcher time
- Lab notebooks and experiment logs
- Patent applications supporting research
- Project meeting minutes discussing uncertainties
Recent enforcement actions:
- IRS Large Business division auditing 80% of large R&D claims
- Criminal investigations of fraudulent credit mills
- New requirements for detailed project descriptions
- Focus on software development claims
The IRS R&D Credit Audit Technique Guide reveals their examination priorities, making proper documentation and conservative claiming essential for businesses seeking this valuable credit.
17. Cryptocurrency and Digital Asset Transactions
Failing to properly report cryptocurrency transactions is one of the fastest-growing audit triggers that increases your odds of being audited by the IRS. The IRS audit chance for crypto investors has quadrupled since 2020, as the agency receives increasing amounts of data from exchanges and blockchain analysis firms.
Key reporting requirements:
- Form 1040 question: Must answer truthfully about crypto activity
- Capital gains reporting: Required for all trades/exchanges
- Income reporting: Mining rewards, staking income, airdrops
- FBAR filings: For foreign exchange accounts exceeding $10,000
Audit red flags:
- Large transactions without reported cost basis
- Inconsistent reporting between exchanges and tax return
- Failure to report DeFi or NFT transactions
- Omitting crypto received as payment for services
- Claiming excessive losses without documentation
Compliance strategies:
- Use crypto tax software to reconcile all transactions
- Maintain records of wallet addresses and private keys
- Document cost basis for all acquisitions
- Report forks and airdrops as ordinary income
- Consider filing amended returns for past omissions
The IRS Virtual Currency Compliance Campaign has resulted in:
- Over 10,000 warning letters sent to crypto holders
- John Doe summonses to major exchanges
- Development of blockchain forensic tools
- Coordination with international tax authorities
With the IRS prioritizing crypto enforcement, proper reporting is essential to avoid severe penalties that can reach 75% of unpaid tax for willful violations.
18. Foreign Bank Account Reporting (FBAR) Violations
Failing to disclose foreign financial accounts will dramatically increase your odds of being audited by the IRS. The IRS audit chance for taxpayers with international connections is exceptionally high, as the agency receives automatic account information from over 100 countries under FATCA and other agreements.
Critical reporting thresholds:
- FBAR (FinCEN 114): Aggregate $10,000+ in foreign accounts
- Form 8938: Higher thresholds based on residency (50,000−50,000−600,000)
- FATCA reporting: Required by foreign financial institutions
Penalty risks:
- Non-willful violations: $10,000 per account per year
- Willful violations: Greater of $100,000 or 50% of account balance
- Criminal charges: Possible for deliberate concealment
Audit triggers:
- Foreign address on tax return
- Foreign-sourced income
- FATCA data received from foreign banks
- Large unexplained deposits or withdrawals
- Prior non-compliance history
Compliance options:
- Streamlined Filing Procedures: For non-willful violations
- Delinquent FBAR Submission: For missed filings without IRS notice
- Voluntary Disclosure Program: For willful violations
The IRS Offshore Compliance Initiative has collected over $15 billion since 2009, making proper foreign account disclosure essential for anyone with international financial connections. With automatic data exchanges now routine, the risk of detection has never been higher.