There’s no sugarcoating it: the more you earn, the more likely the IRS is to take a closer look. But an audit isn’t inevitable and with proper planning, you can stay compliant and confident.
Here’s what high earners need to know about audit risk and how to reduce it.
Common Triggers
Large charitable deductions, especially those that seem disproportionate to income, are frequent red flags. For example, if your charitable contributions are unusually high compared to your Adjusted Gross Income (AGI), the IRS may scrutinize them. Ensure all donations are properly valued and documented with receipts, acknowledgment letters from charities, and qualified appraisals for non-cash donations over a certain amount (generally $5,000). Disproportionate business losses that consistently offset income can also trigger scrutiny. The IRS may question whether your business is genuinely for profit or a hobby. Maintaining accurate financial records and a clear business purpose for all expenses is crucial. Additionally, failing to report foreign income or accounts is a major trigger. If you have offshore accounts or assets valued over $10,000, you are required to file FinCEN Form 114 (FBAR) and potentially IRS Form 8938. Be sure to declare all overseas assets and earnings in accordance with IRS regulations. Consistency and thorough documentation are key to avoiding these common pitfalls.
Entity Errors
Filing as an S-Corp or partnership? Incomplete K-1s, where income and deductions are not properly reported, can catch attention. Discrepancies between what is reported on your personal return and the K-1s can lead to an audit. Passive activity losses, particularly if claimed against active income without justification, may raise questions, as there are strict rules for deducting passive losses. Late filings of required forms or returns also increase the likelihood of an audit. It’s essential to ensure all entity filings (such as Form 1120-S for S-Corps or Form 1065 for partnerships) are accurate, complete, and submitted on time. Proper accounting and a clear understanding of the entity’s tax obligations are vital.
Crypto and Alternative Investments
Failing to report digital assets like cryptocurrency or alternative investments properly is a growing audit trigger. The IRS is increasing its focus on compliance in this area. For transactions beginning on or after January 1, 2025, brokers are required to report dispositions of digital assets on the new Form 1099-DA. If you’re active in these areas, maintaining detailed records of transactions, including purchase and sale dates, costs, and proceeds, is essential. Seek expert oversight to ensure you are complying with the latest tax guidelines for these evolving asset classes, including reporting all taxable events such as sales, conversions, and staking rewards. Ignoring the reporting requirements can lead to significant penalties and increased audit risk.
Personal vs. Business Expenses
Don’t blur the lines between personal and business expenses. Home office write-offs must meet strict IRS criteria, including exclusive and regular use of a portion of your home for business. This deduction is primarily for self-employed individuals and independent contractors; it is suspended for employees from 2018 through 2025. Vehicle expenses should be meticulously tracked, with mileage logs and clear documentation of business use. The IRS rarely believes 100% business use of a personal vehicle. Travel deductions must also be clearly business-related, with detailed itineraries, receipts, and proof of business activities. Be prepared to justify all deductions and demonstrate their legitimate business purpose, as excessive deductions for meals, travel, or home office expenses can raise red flags.
Amended Returns
While fixing past errors with amended returns (Form 1040-X) is smart, multiple amended returns or large changes can raise red flags. These can suggest errors in original filings or attempts to manipulate tax liability. It’s best to get it right the first time by ensuring accuracy and thoroughness in your initial submissions. If amendments are necessary, be prepared to provide detailed explanations and supporting documentation to justify the changes, as the IRS systems are designed to detect inconsistencies.
Securing Your Financial Future
Audit risk rises with income, but fear shouldn’t drive your strategy. Confidence comes from clarity, accuracy, and a proactive plan. Working with qualified tax professionals can significantly reduce your audit risk and ensure compliance with complex tax laws. By maintaining meticulous records, understanding your obligations, and staying informed about changes in tax regulations, you can protect your wealth and your peace of mind. The IRS is increasing its focus on high-income earners with additional funding and improved audit algorithms for 2025 and beyond.
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At Tax Advisors of Cary, we’re dedicated to helping you navigate complex filings, maximize deductions, and achieve your financial goals with confidence. Connect with us today to schedule an appointment and discover how our expert team can make tax season easier and more rewarding. Let’s work together for your success!
