The DIF Score
The IRS uses a computer scoring system called the Discriminant Information Function, or DIF, to flag returns for audit. The DIF score compares your return to statistical norms for your income level and occupation. The further your return deviates from the norm, the higher your DIF score, and the more likely you are to be audited.
The Top 10 Red Flags
High income is the biggest factor. If you earn more than $1 million, your audit rate jumps significantly. Large charitable deductions relative to income raise flags because they deviate from the norm. Home office deductions are scrutinized because they are frequently abused.
Rental property losses, especially if you are not a real estate professional, get attention because the passive activity rules are complex and often violated. Cash-intensive businesses like restaurants, bars, and retail stores are targets because the IRS assumes unreported cash income.
Cryptocurrency transactions are a current priority for the IRS. Foreign bank accounts and foreign income trigger additional scrutiny. Large business meal and entertainment deductions are magnets for auditors. Round numbers on your return suggest estimation rather than actual record keeping. And not filing at all is the ultimate red flag.
What to Do If You Are Audited
Do not panic. An audit is not an accusation of fraud. It is a verification process. Gather your documentation, hire a tax attorney or CPA to represent you, and let your representative handle the communication with the IRS. Do not answer questions or provide documents without your representative present. The audit process has rules and deadlines that work in your favor when you know how to use them.