What is your IRS Audit Risk? A quick reference guide
The IRS’s audit strategy for the 2025 tax year is highly targeted, focusing primarily on wealthy individuals and complex corporate structures rather than broad, random audits. Your audit risk is strongly correlated with your income level, filing complexity, and the presence of specific red flags.
Overall Audit Strategy
The IRS has publicly committed to maintaining historically low audit rates for individuals and small businesses earning under $400,000 annually. The increased enforcement efforts funded by recent legislation are directed almost entirely toward high-net-worth filers, large corporations, and complex partnerships.
Highest Risk Categories
Your audit risk is highest if you fall into one of these complex, high-net-worth filing categories:
Wealthy Individuals (Earning $10 Million+): The IRS has projected a significant increase in audits for this group, focusing on issues like complex trust and estate structures, unreported offshore assets, private business valuations, and large cryptocurrency transactions.
Large Corporations: Companies with assets exceeding $250 million are seeing a major increase in scrutiny, with a focus on transfer pricing and large international tax matters.
Complex Partnerships: Partnerships with assets over $10 million face increased attention regarding non-economic losses, tax basis reporting, and disproportionate allocations among partners.
Increased Risk: Common Red Flags
Regardless of your income level, certain activities trigger the IRS’s automated Discriminant Function System (DIF) score, making your return more likely to be selected for manual review:
Self-Employed (Schedule C): High-risk indicators include reporting a business loss for three or more consecutive years (which can lead to the activity being reclassified as a hobby), or deducting business expenses (travel, meals, auto use) that are far out of line with industry averages.
Unreported Income: This is a major trigger. If the income reported on a W-2, 1099 (e.g., INT, DIV, NEC), or third-party payment report (1099-K) does not match the income you report on your return, the IRS will automatically generate a notice.
Digital Assets (Cryptocurrency): If you checked “Yes” to the question on Form 1040 regarding receiving, selling, or exchanging digital assets, you must have meticulous records to support all reported gains and losses.
High Itemized Deductions: Taking itemized deductions, particularly for charitable giving or business expenses, that are unusually large relative to your Adjusted Gross Income (AGI) will often flag your return.
Foreign Accounts: Failure to properly report foreign financial accounts (using FBAR for accounts over $10,000) or foreign financial assets (using Form 8938) creates a high risk of audit and substantial penalties.
Lowest Risk Categories
Your audit risk remains minimal if your financial situation is straightforward:
W-2 Wage Earners: Individuals whose income is solely from wages, where the income is fully verified by the employer, face the lowest audit rates (typically less than 0.1%).
Individuals Under $400,000: Those below this threshold are not the current target of the IRS’s strategic enforcement push.
Small S Corporations and Partnerships: Generally have much lower audit rates than large corporate structures.
The IRS Audit Selection Process
The IRS primarily uses sophisticated, computerized methods to identify returns with the highest probability of errors, rather than conducting random checks.
The Computer Score (DIF System)
The primary screening tool is the Discriminant Information Function (DIF) system. This software compares your deductions, credits, and income against statistical norms for millions of other taxpayers who share a similar income level and occupation. If your return deviates significantly from the average for your peer group—for instance, if your charitable giving or travel expenses are disproportionately high—your DIF score increases, flagging the return for review by a human agent.
Information Matching
This is the simplest and most common trigger. The IRS’s computer system automatically cross-references every income document it receives (W-2, 1099-INT, 1099-DIV, 1099-NEC, etc.) with the income reported on your Form 1040. Any discrepancy, even a minor one, will generate an immediate inquiry, usually a CP2000 notice, which is a form of correspondence audit.
Related Examinations and Whistleblowers
Your return may be selected if you are linked to another taxpayer who is already under audit, such as a business partner, investor in a partnership, or related trust. Additionally, specific tips received through the IRS Whistleblower program often lead to targeted investigations of high-net-worth individuals and complex businesses.
Detailed Audit Red Flags
These are the most common areas that cause a return to be flagged, as they represent the easiest opportunities for unsupported claims or tax evasion:
Self-Employed (Schedule C) Losses: Reporting a business loss for three out of five consecutive years is a major red flag, as it suggests the activity may be a hobby rather than a legitimate business, leading the IRS to disallow all losses.
Home Office Deduction: This is highly scrutinized. The space must be used exclusively and regularly for business. Using the same room as a guest bedroom or a personal study disqualifies the deduction entirely.
Unusual or Large Deductions: Any itemized deduction that is unusually high compared to your Adjusted Gross Income (AGI) raises a flag. This includes claiming large, non-cash charitable donations without a formal appraisal and the required Form 8283 (for donations over $5,000).
Digital Assets and Foreign Accounts: Failing to accurately report all gains and losses from cryptocurrency transactions or failing to file the FBAR (Foreign Bank Account Report) for any foreign account that exceeded $10,000 at any point during the year are high-risk omissions.
Round Numbers: Using too many round figures (e.g., claiming $5,000 for travel, $2,000 for supplies) is suspicious, as it suggests the figures were estimated rather than backed by actual receipts and detailed records.
The Three Types of IRS Audits
If the IRS decides to formally examine your return, you will only be notified by mail. The notice will clearly indicate the type of audit:
Correspondence Audit: This is the most common and least severe type, accounting for about 75% of all examinations. It is conducted entirely through the mail and typically focuses on verifying one or two specific items, such as a single deduction amount or an income mismatch.
Office Audit: This involves a face-to-face meeting with an IRS agent at a local IRS office. These audits cover more complex returns than correspondence audits, often focusing on Schedule C or E, or a broader review of all itemized deductions.
Field Audit: This is the most intrusive and comprehensive type. The agent will visit your home or principal place of business. Field audits are typically reserved for the largest corporations, complex high-net-worth individual returns, and extensive small business returns that require a deep dive into financial records and physical assets.
