Tax authorities like the IRS and ATO use data analytics to target individuals and businesses that show a higher risk of non-compliance. You are most likely to be audited if you are a high-income earner, run a cash-based business, or have discrepancies in your reported income and deductions.
Top IRS audit triggers
They can be triggered if the ATO notices that the numbers don't add up: Failure to declare income. Improperly claiming deductions. Your lifestyle not matching your nominal income.
Which Taxpayers the IRS Audits Most Often. Oddly, people who make less than $25,000 have a relatively high audit rate. This higher rate is because many of these taxpayers claim the earned income tax credit, and the IRS conducts many audits to ensure that the credit isn't being claimed fraudulently.
Generally, the problems are identified by a computer. District offices select returns randomly sometimes for special research programs, but generally the returns are selected because they have good audit potential. The potential is discovered by a computerized system called the Discriminant Function System (DIF).
While most taxpayers' chance of audit is less than 1%, the odds increase once you earn $500,000 or more in taxable income.
The four primary types of audits often discussed are Financial Audits, Compliance Audits, Operational Audits, and Internal Audits, though sometimes the focus is on the four types of audit opinions (Unqualified, Qualified, Adverse, Disclaimer) or other classifications like IT/Information Systems Audits or Forensic Audits. Generally, audits assess financial records, adherence to rules, operational efficiency, or internal controls, providing insights for stakeholders and improving business processes.
Not reporting all of your income is an easy-to-avoid red flag that can lead to an audit. Taking excessive business tax deductions and mixing business and personal expenses can lead to an audit. The IRS mostly audits tax returns of those earning more than $200,000 and corporations with more than $10 million in assets.
There are five potential threats to auditor independence: self-interest, self-review, advocacy, familiarity, and intimidation. Any lack of independence compromises the integrity of financial markets.
The IRS usually reviews receipts during an audit — if you don't have the receipts, you can sometimes use bank statements or credit card statements to prove your claims instead. Consequences of being audited without receipts can include additional taxes, interest, and financial penalties.
'Red flags' that can catch the ATO's attention
“Red flags typically arise where claims are inconsistent with income levels, industry norms, or prior-year behaviour,” he told Yahoo Finance. “Large jumps in deductions, especially for motor vehicles, home-office expenses, or self-education, tend to draw attention.
The Australian tax office is using AI to track even the smallest income transactions, with Aussies warned they'll be caught for under-reporting even $50, as the tax return deadline looms. The ATO statistics reveal there are 91 millionaires who are not paying their tax properly.
How to Avoid Getting Audited by ATO
There are three main types of audit risk—inherent risk, control risk, and detection risk—along with a fourth related concept, sampling risk, which can affect the reliability of audit evidence.
Most taxpayers will do anything they can to avoid tax audits. Filling out an accurate tax return is the best way to avoid an audit. Additionally, you should ensure you double-check your math and only claim legitimate tax deductions. E-filing may also be helpful.
It's good to be specific, but there's a danger in words such as “everything,” “nothing,” “never,” or “always.” “You always” and “you never” can be fighting words that can distract readers into looking for exceptions to the rule rather than examining the real issue.
Balancing the 3 C's in Auditing Practice
Balancing competence, confidentiality, and communication is essential for the effectiveness of the auditing process.
Audit findings are critical in assessing the performance, compliance, and efficiency of an organization. To ensure these findings are clear, actionable, and impactful, auditors use a framework called the 5 C's: Criteria, Condition, Cause, Consequence, and Corrective Action.
Self-Review Threat
A self-review threat exists if the auditor is auditing his own work or work that is done by others in the same firm. The auditor prepares the financial statements for ABC Company while also serving as the auditor for ABC Company.
Misreporting Your Income
If you incorrectly report your income, it can increase your chance of being audited. This includes: Reporting a higher-than-average income. Rounding up your income.
The $600 rule says that any business that pays you more than $600 is required to file a 1099 with the IRS and give you a copy. Tax law says that you have to report all of your income on your tax return even if you never get a 1099.
Red flags are warning signs that something in a relationship may be unhealthy, toxic, or potentially harmful. They signal behaviours or patterns that, if ignored, could lead to emotional distress or even abuse. Common red flags include manipulation, lack of trust, controlling behaviour, and poor communication.
A successful internal audit function relies on four fundamental pillars, often referred to as the “4 C's”: Competence, Confidentiality, Communication, and Collaboration. These principles guide auditors in delivering meaningful and impactful results.
A financial audit is one of the most common types of audit. Most types of financial audits are external. During a financial audit, the auditor analyzes the fairness and accuracy of a business's financial statements. Auditors review transactions, procedures, and balances to conduct a financial audit.
Accountants who specialize in auditing evaluate financial records to validate accuracy. They may focus on internal or external audits to ensure that a company's income statement, balance sheet, and cash flow statements are in compliance with tax laws, regulations, and all applicable accounting standards.