Most people think of IRS audits as random or arbitrary. They are neither. The IRS uses several distinct methods to identify returns worth examining, and understanding those methods is the first step toward understanding what makes your return risky.

1. The Discriminant Function System (DIF)

The primary selection tool is the Discriminant Function System, or DIF. The IRS states that returns may be selected for examination through random selection and computer screening, related examinations, and third-party documentation mismatches. The IRS has long used computerized scoring systems in examination selection, but the precise formulas are not publicly disclosed. Returns flagged by the system are reviewed by IRS classifiers, who apply human judgment before a formal examination is opened. A high score is what gets your return into that review queue in the first place.

The IRS also uses a supplemental tool called the Unreported Income DIF (UIDIF), which specifically targets returns with a higher statistical probability of unreported income. A return can generate attention under the UIDIF even if its reported deductions appear normal, simply because income levels appear inconsistent with lifestyle or third-party-reported figures.

2. Information matching

When employers, financial institutions, and other payers file information returns (W-2s, 1099-NEC forms, 1099-K forms, 1099-INT forms, and others), the IRS automatically cross-references those documents against what was reported on the taxpayer’s return. Mismatches between third-party-reported income and what appears on the return are flagged automatically and processed through the Automated Underreporter (AUR) Program. In FY 2024, the AUR Program generated $7.7 billion in additional assessments, according to the IRS FY 2024 Data Book. This is not a traditional audit, but it can escalate into one.

3. Related party examinations

If the IRS is already auditing someone connected to you, such as a business partner, co-investor, employer, or client, your return may be pulled for examination as part of the same inquiry. The IRS refers to these as “related examinations” and uses them to trace income and expense flows across multiple connected returns simultaneously.

4. Whistleblower tips and third-party information

The IRS Whistleblower Office receives tips from third parties who report suspected tax non-compliance. Under IRC Section 7623, eligible informants can receive a portion of the collected proceeds. Tips from former business partners, disgruntled employees, or competitors can and do lead to IRS examinations.

5. Specific issue targeting and compliance campaigns

The IRS Large Business and International (LB&I) division periodically announces compliance campaigns that focus on specific industries, transaction types, or tax positions. Examples have included virtual currency transactions, syndicated conservation easements, micro-captive insurance arrangements, and certain international income reporting issues. If your return involves a position that falls within a current IRS campaign, your audit risk is materially elevated regardless of your DIF score.

6. Random sampling (NRP audits)

A small number of returns are selected for examination through the National Research Program (NRP), which uses statistical random sampling to gather compliance data. NRP audits are line-by-line examinations that the IRS uses to calibrate its DIF formulas. The probability of being selected for an NRP audit in any given year is very low, but NRP audits are among the most thorough examinations the IRS conducts because every item on the return is subject to scrutiny, not just flagged issues.

The IRS releases an annual Data Book that provides examination statistics for the prior fiscal year. The FY 2024 Data Book, released in 2025, shows that the IRS closed 505,514 audits in FY 2024. The following table reflects individual income tax return examination coverage reported in the FY 2024 IRS Data Book for Tax Year 2022 returns, broken down by total positive income bracket. These are approximate rates per 1,000 returns filed, derived from Table 17.

Source: IRS FY 2024 Data Book, Table 17. Rates are approximations derived from the published examination-coverage percentages for Tax Year 2022 returns.

Types of audits: correspondence vs. field

Not all audits are equal in scope or burden. According to the FY 2024 Data Book, 77.9 percent of audits closed in FY 2024 were correspondence audits, which are conducted entirely by mail and typically address a single identified issue. The FY 2024 Data Book classifies the remaining 22.1 percent of closed examinations as field examinations, while IRS publications more broadly describe in-person examinations as occurring at an IRS office, your home, your place of business, or your representative’s office. Although field examinations represent a smaller share, they generated $23 billion of the $29 billion in recommended additional tax in FY 2024, reflecting the far greater complexity and stakes of in-person examinations of business returns.

The DIF system is, at its core, a comparison tool. It measures whether the deductions on your return are statistically proportionate to returns filed by taxpayers with similar income, industry, and filing characteristics. When your deductions deviate significantly from the statistical norm for your peer group, your DIF score rises accordingly.

This does not mean large deductions are improper. A business with legitimately large expenses in a given year should claim them. But it does mean that when your return looks like an outlier, the IRS is more likely to look at it. Common areas where disproportionate deductions attract scrutiny include:

• Business expenses as a percentage of gross revenue: A Schedule C that reports $200,000 in gross income but $190,000 in deductions produces an exceptionally high expense ratio that the DIF system will flag.
• Charitable deductions: The IRS compares charitable contributions to income. Contributions that are a large multiple of what the average filer at your income level reports will elevate your score.
• Miscellaneous itemized deductions: These deductions, where still applicable, attract scrutiny at high levels.

Vehicle expenses are one of the most scrutinized items on any business return, and for good reason: they are also one of the most commonly abused. When a taxpayer claims that a personal vehicle is used 100 percent for business, the IRS is statistically skeptical, because almost no one who owns a vehicle uses it exclusively for business. Even a single personal trip, including commuting to and from your regular place of business, disqualifies a vehicle from 100 percent business use.

What the IRS requires for vehicle deductions

Under IRC Section 274, business vehicle deductions require contemporaneous records, meaning a mileage log maintained at or near the time of each trip. The log must record the date, destination, business purpose, and miles driven for each business use. Reconstructed logs prepared after an audit notice arrives are given substantially less weight by examiners than logs kept in real time.

For listed property (which includes vehicles), you must be able to substantiate the actual business-use percentage. If the IRS examines your return and finds that your claimed 100 percent business use cannot be documented, the entire vehicle deduction is at risk, and the IRS may assess significant additional tax, penalties, and interest. If you acquired the vehicle through a Section 179 expensing election or bonus depreciation and the business-use percentage was subsequently determined to be less than 50 percent, additional recapture rules apply.

The home office deduction is one of the most legitimate and valuable deductions available to self-employed individuals and small business owners. It is also one of the most frequently disallowed. The reason is not that claiming a home office is inherently risky; it is that the legal standard is strict and many taxpayers fail to meet it.

The IRC Section 280A requirements

Under IRC Section 280A, a home office deduction is allowed only if the space is used regularly and exclusively as the taxpayer’s principal place of business, as a place to meet clients or customers in the normal course of business, or (in limited circumstances) as a separate structure used in connection with the business. Both elements of the test must be met: regular use and exclusive use. A guest bedroom that doubles as an office, a kitchen table used for occasional paperwork, or a living room corner where you sometimes work do not qualify.

The “exclusive use” requirement is an absolute standard under the statute. A space used even occasionally for personal purposes does not satisfy it. The IRS examines this issue carefully because the statute is strict and taxpayers frequently misunderstand or misapply it.

How the deduction is calculated

There are two methods for calculating the home office deduction. The regular method requires calculating the percentage of your home devoted exclusively to the office (by square footage or number of rooms) and applying that percentage to qualifying home expenses such as mortgage interest, rent, utilities, insurance, and depreciation. The simplified method, introduced in 2013, allows a flat deduction of $5 per square foot of qualifying space, up to a maximum of 300 square feet (a maximum deduction of $1,500 per year), but disallows depreciation. The regular method produces a larger deduction in most cases but requires more documentation.

Businesses that primarily transact in cash, including restaurants, bars, food trucks, nail salons, hair salons, car washes, landscaping companies, contractors, and certain retail operations, are subject to significantly elevated IRS scrutiny. The reason is straightforward: cash receipts are harder to verify through third-party information returns, which makes them easier to underreport. The IRS is well aware of this, and its examiners have specific training and techniques for cash-business audits.

How the IRS audits cash businesses

When examining a cash-intensive business, IRS agents often use indirect methods of income reconstruction rather than relying solely on the books presented by the taxpayer. Common techniques include:

• Bank deposit analysis: The IRS reviews all bank deposits to identify whether total deposits are consistent with reported gross receipts. Unexplained deposits are treated as potential unreported income.
• Net worth analysis: The agent compares beginning and ending net worth plus living expenses to reported income, looking for increases in assets that cannot be explained by after-tax reported income.
• Cash “T” method: The agent reconstructs cash on hand at the beginning and end of the year to assess whether the reported income is consistent with cash flows.
• Markup methods: The IRS may use industry-standard markup ratios, comparing the cost of goods purchased to expected gross revenue, to estimate whether reported receipts are consistent with the business’s purchasing activity.

This is one of the subtler red flags, but it is a well-established pattern in IRS examination practice. Real business expenses rarely come out in perfectly round numbers. Actual receipts produce figures like $4,287, $12,344, or $8,765. When a return consistently shows round numbers, such as $5,000 in travel, $10,000 in meals, $3,000 in supplies, it signals to IRS classifiers that the figures may have been estimated rather than derived from actual records.

Round numbers are not an automatic audit trigger, but they are a marker that correlates with poor recordkeeping. And poor recordkeeping is itself a major audit risk, because the IRS’s burden in an examination is much easier to meet when a taxpayer cannot produce contemporaneous documentation for claimed deductions. Under IRC Section 6001, every taxpayer is required to maintain adequate records sufficient to determine tax liability. The obligation to keep records belongs to the taxpayer, not the IRS.

Meals and entertainment deductions have long been a focus of IRS enforcement because they are among the most heavily abused categories of business expense. The Tax Cuts and Jobs Act of 2017 (TCJA) made the landscape significantly more restrictive. Under current law, business meal expenses that meet the substantiation requirements of IRC Section 274 are generally deductible at 50 percent, and entertainment expenses (tickets to sporting events, concerts, golf outings, and similar activities) are generally not deductible, even if they have a business purpose, unless an exception in IRC Section 274(e) applies.

What the IRS looks for

An examiner auditing meals and entertainment will look for what the regulations require: for each claimed expense, documentation of the amount, the date and place, the business purpose, and the names and business relationships of the people present. Without contemporaneous records meeting these criteria, the deduction is disallowed.

The IRS also compares meals and entertainment deductions as a percentage of gross revenue to industry norms. A restaurant that spends heavily on food for staff meals has a defensible explanation. A sole-proprietor consultant claiming $30,000 in meal deductions on $100,000 of income does not. The DIF system uses industry and income comparisons to flag returns where this ratio is outside the statistical norm.

Every business goes through difficult years, and a legitimate business that reports losses has every right to deduct them. But the IRS is also aware that some taxpayers use “businesses” with enjoyable personal elements, photography, travel, wine, horses, antiques, and similar activities, to generate paper losses that offset other income while the activity is actually pursued for pleasure rather than profit. IRC Section 183 addresses this directly and is one of the most litigated provisions in the Internal Revenue Code.

IRC Section 183: the hobby loss rule

Under IRC Section 183, if an activity is “not engaged in for profit,” no deduction attributable to that activity is allowed beyond the gross income it generates in the same year. This effectively eliminates the ability to use hobby losses to offset other income.

Section 183 includes a statutory safe harbor: if an activity generates a profit in at least three of the five consecutive taxable years ending with the year in question, it is presumed to be engaged in for profit. (For activities involving the breeding, training, showing, or racing of horses, the safe harbor requires profit in two of seven years.) If you meet the safe harbor, the burden shifts to the IRS to prove the activity is not a business. If you do not meet the safe harbor, the burden is on you to prove profit motive through objective facts and circumstances.

What the IRS examines

The IRS regulations under Section 183 identify nine factors relevant to the profit motive analysis, including the manner in which the activity is carried on, the expertise of the taxpayer, the time and effort invested, the expectation of asset appreciation, prior success in similar activities, the history of income and losses, and the extent to which the activity has elements of personal recreation or pleasure. No single factor is determinative, and the IRS will examine all nine.

In practice, the audit risk under Section 183 escalates significantly when the same return shows:

• Losses from an activity that appears to have significant personal enjoyment elements
• Three or more consecutive years of losses with no trend toward profitability
• The taxpayer has significant other income that the losses offset
• The activity involves travel, equipment, or other perks with personal use potential

Charitable deductions are a legitimate and valuable part of the tax code, and large charitable giving is not inherently problematic. But the IRS’s DIF system compares charitable contribution deductions to income and flags returns where contributions are disproportionately large relative to the taxpayer’s AGI and income bracket. Once flagged, examiners look at whether the proper substantiation requirements have been met.

The substantiation rules

The substantiation requirements for charitable contributions under IRC Section 170 are specific and must be satisfied contemporaneously (meaning before the tax return is filed, not reconstructed afterward during an audit):

• Cash contributions under $250: A bank record, canceled check, or written communication from the donee organization showing the date, amount, and name of the organization is required.
• Cash contributions of $250 or more: A written acknowledgment from the donee organization is required, stating the amount of cash contributed and whether any goods or services were provided in exchange.
• Non-cash contributions over $500: Form 8283 must be attached to the return, and additional records regarding the donated property are required.
• Non-cash contributions over $5,000: A qualified appraisal of the property is required, and the appraiser must sign Form 8283. This requirement catches many taxpayers who donate vehicles, artwork, real estate, or business interests without obtaining a proper qualified appraisal.

Conservation easements: a specific IRS target

Syndicated conservation easements have been a priority IRS enforcement target. The IRS has placed certain conservation easement transactions on its list of listed transactions, and participation in them can trigger an examination of multiple years’ returns. If your return includes a large conservation easement contribution, consult with a tax attorney before assuming the deduction is defensible.

The IRS’s Automated Underreporter Program exists specifically to catch situations where income reported by third parties does not match income reported by the taxpayer. Every payer who issues a Form 1099-NEC, 1099-MISC, 1099-K, 1099-INT, 1099-DIV, 1099-B, or any other information return sends a copy to the IRS. The IRS matches those forms electronically against the taxpayer’s return. A mismatch is automatically flagged.

1099-NEC and contractor income

Freelancers, consultants, and independent contractors receive Form 1099-NEC from clients who paid them $600 or more during the calendar year. Every 1099-NEC issued in your name is in the IRS’s database. Omitting income reported on a 1099-NEC, even inadvertently, is one of the most direct triggers for an AUR notice that can escalate into a full examination.

Cryptocurrency and digital asset income

The IRS treats cryptocurrency and other digital assets as property, not currency. Since the IRS added a digital asset question to the top of Form 1040, the agency has made clear that cryptocurrency transactions are a compliance priority. Under current IRS guidance, broker reporting for digital asset transactions is required on Form 1099-DA for covered transactions beginning on or after January 1, 2025. The IRS also obtains information through John Doe summonses served on major exchanges. Every taxable cryptocurrency event, including selling, trading, or using crypto to purchase goods and services, must be reported. Non-reporting is not a gray area; it is a direct audit trigger with criminal referral potential in egregious cases.

Bartering income

Barter exchanges are required to issue Form 1099-B to participants, and barter transactions outside a formal exchange are also taxable as ordinary income at the fair market value of goods or services received. Bartering is frequently overlooked as a taxable event, and the IRS’s information matching systems catch omissions when third-party reporting exists.

Schedule C (Profit or Loss from Business) is the form on which sole proprietors and single-member LLCs (taxed as disregarded entities) report business income and expenses. It is also one of the most heavily scrutinized schedules the IRS reviews. The reason is structural: unlike a W-2 employee, a Schedule C filer self-reports income without employer withholding, and self-reports expenses without the oversight of a payroll department or corporate accounting function. The entire determination of taxable business income rests on what the taxpayer chooses to report.

The IRS’s DIF system compares Schedule C deductions to industry norms by NAICS code (the North American Industry Classification System code that identifies what type of business the taxpayer operates). When deductions in any category, such as travel, meals, contract labor, supplies, or “other expenses,” are outside the statistical norm for the taxpayer’s industry and income level, the DIF score rises.

Why Schedule C filers face elevated scrutiny

• Self-employment income has historically had the highest non-compliance rates in the voluntary reporting system, as documented in IRS tax gap studies.
• Schedule C provides the broadest opportunity for expense deductions of any form a typical individual filer submits.
• The line items on Schedule C include categories that are easy to inflate, hard to verify without contemporaneous documentation, and commonly abused: travel, meals, advertising, and “other expenses.”
• Self-employment tax (15.3 percent on net self-employment income up to the Social Security wage base) creates a direct financial incentive to minimize net Schedule C income through deductions.

U.S. tax law is based on citizenship and residency, not the location of income. U.S. persons (including citizens, resident aliens, domestic corporations, partnerships, LLCs, trusts, and estates) are required to report and pay tax on their worldwide income, regardless of where it is earned or held. The IRS has devoted substantial enforcement resources to identifying offshore non-compliance, and the penalties for failure in this area are among the most severe in the Internal Revenue Code.

FBAR: FinCEN Form 114

Under the Bank Secrecy Act, any U.S. person who has a financial interest in, or signature or other authority over, one or more foreign financial accounts must file a Report of Foreign Bank and Financial Accounts (FBAR) using FinCEN Form 114 if the aggregate maximum value of all such accounts exceeded $10,000 at any point during the calendar year. The FBAR is not filed with the IRS; it is filed electronically with the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Treasury Department. It is due by April 15 of the following year, with an automatic extension to October 15.

FBAR penalties are among the most severe in tax law. Non-willful FBAR violations can result in civil penalties of up to the applicable inflation-adjusted amount per violation, and the penalty framework should be analyzed carefully in light of Bittner v. United States, in which the Supreme Court held that non-willful penalties accrue on a per-report rather than per-account basis. Willful violations can result in penalties equal to the greater of $100,000 (adjusted for inflation) or 50 percent of the balance in the account per violation, plus potential criminal prosecution.

Form 8938: FATCA

In addition to the FBAR, U.S. taxpayers with specified foreign financial assets exceeding certain thresholds must file Form 8938 (Statement of Specified Foreign Financial Assets) with their federal income tax return under the Foreign Account Tax Compliance Act (FATCA). The thresholds vary based on filing status and residency. Form 8938 is filed with the IRS (unlike the FBAR, which goes to FinCEN), and the two forms cover overlapping but distinct categories of assets. Compliance with one does not satisfy the obligation to file the other.

Foreign income: wages, rental income, and business income

Business owners with international operations, foreign rental properties, interests in foreign corporations or partnerships, or employment by foreign employers must report that income on their U.S. federal return. The IRS coordinates with foreign tax authorities through tax treaties, tax information exchange agreements, and FATCA-related information-sharing arrangements, which means foreign financial account and income information is increasingly visible to the IRS through channels other than voluntary disclosure.

Prior audit history is a documented factor in return selection. A taxpayer whose return was examined in a prior year and resulted in a significant adjustment is at elevated risk of being selected again in subsequent years, particularly if the issue that generated the adjustment is a recurring one. The IRS tracks examination history, and returns from taxpayers with prior examination activity may receive closer scrutiny than returns from taxpayers with no prior history.

Related party examinations

As noted in the selection criteria section above, the IRS actively uses related party examinations to broaden audit scope. If a business partner, co-investor, or pass-through entity in which you hold an interest is under examination, your individual return is at elevated risk of being pulled into the same inquiry. This is especially relevant for partners in partnerships and shareholders in S corporations, where the pass-through entity return and the individual shareholders’ returns are functionally linked.

When a prior examination resulted in no change

A prior “no-change” audit result (one in which the IRS made no adjustments) does not eliminate future audit risk. It can, however, be useful evidence in defending the same position in a subsequent examination of the same item if the facts and circumstances have not changed. Retaining records of prior examinations and their outcomes is advisable.

Receiving an IRS audit notice is stressful. It is also important to respond to it correctly, because how you respond in the initial stages of an examination significantly affects the ultimate outcome. The following steps reflect established best practices for taxpayers who receive an audit notice.

Step 1: Do not panic, but do not ignore it

Most IRS audit notices are correspondence audits that address a single specific item. Many are resolved without a material change to your tax liability. But ignoring a notice does not make it go away. Failure to respond by the stated deadline typically results in the IRS assessing the full amount it has proposed as additional tax, plus interest and penalties, without any opportunity for you to contest the adjustment through the examination process.

Step 2: Read the notice carefully and identify what is being examined

IRS correspondence follows specific formats. The notice will identify the tax year under examination, the specific line items being questioned, and the response deadline. Read it carefully. In many cases, the IRS is asking for documentation to substantiate a specific deduction, not challenging your entire return.

Step 3: Contact a tax attorney before contacting the IRS

This is the most important step. Before you call the IRS, write to the IRS, or provide any documents, consult with a qualified tax attorney or other authorized representative. Anything you say to an IRS examiner can be used to expand the scope of the examination. A tax attorney can review the notice, assess the strength of your position, identify whether the examination is limited in scope or likely to expand, and represent you in all communications with the IRS.

Under the Taxpayer Bill of Rights, you have the right to retain an authorized representative and to have that representative present during all IRS proceedings. Exercise that right.

Step 4: Gather your records

Identify and organize the documentation relevant to the items under examination. If there are gaps in your records, note them and discuss them with your attorney before the examination begins. The IRS accepts certain secondary evidence when original records are unavailable due to circumstances beyond the taxpayer’s control, but it does not accept excuses for records that should have been kept and were not.

Step 5: Understand your appeal rights

If you disagree with the results of an IRS examination, you have the right to appeal. The IRS Independent Office of Appeals reviews contested examination findings and operates independently of the IRS examination function. Many examination disputes are resolved at the Appeals level without the need for litigation. If Appeals does not resolve the dispute, you have the right to petition the U.S. Tax Court, the U.S. Court of Federal Claims, or your U.S. District Court, depending on the procedural path taken. For more on the full controversy process, see our post on 10 steps to navigate a civil tax controversy.

Audit risk cannot be eliminated entirely. Any return, no matter how accurately prepared, can be selected through random statistical sampling. But the 12 red flags described in this post are all, to varying degrees, within a business owner’s control. The following practices meaningfully reduce the risk that your return will draw IRS scrutiny.

Maintain contemporaneous documentation

This is the single most important thing you can do. The IRS’s ability to disallow deductions in an examination almost always depends on the absence of adequate contemporaneous records. Keep receipts, bank statements, mileage logs, meeting records, business purpose documentation, and anything else that substantiates what you have claimed. Store records for at least seven years from the due date of the return (longer for returns involving foreign income or assets, or returns where income may have been significantly understated).

Use proper business accounting practices

Keep business and personal finances strictly separate. Use a dedicated business bank account, a business credit card, and accounting software that generates records consistent with your return. The absence of these basic practices is a red flag in itself during examination, because it suggests that deductions were estimated rather than derived from actual business records.

Understand how your return compares to industry norms

The DIF system flags returns that are statistical outliers. A tax professional who specializes in your industry can advise you on whether specific deductions are within the range the IRS considers normal for businesses like yours. Deductions that are fully legitimate but statistically unusual benefit from additional documentation and, where appropriate, disclosure statements.

File accurately and completely

Omitting income, even inadvertently, is one of the clearest paths to an IRS examination. Reconcile all 1099s before filing, account for all cryptocurrency transactions, and ensure that every source of income (including barter, rental income, and income from foreign sources) is reported. If you receive a corrected 1099 after filing, consider whether an amended return is appropriate.

Consider the entity structure of your business

The entity type through which you operate a business affects your return type, and different return types carry different examination rates and risk profiles. This is one of the factors relevant to business formation and structuring decisions, and it deserves consideration during the planning process. For a detailed comparison of the tax implications of different business structures, see our post on LLC vs. corporation: tax implications and how to choose the right structure in 2026.

Work with a qualified tax professional

Returns prepared by licensed tax professionals are generally more accurate and better documented than self-prepared returns. In addition to reducing the risk of an audit notice in the first place, having a qualified preparer means you have someone who understands the return and can represent you if an examination occurs. This is particularly valuable for business returns, which are more complex and carry higher examination stakes than simple individual returns.

According to the IRS FY 2024 Data Book, the IRS closed 505,514 audits in FY 2024. The overall examination coverage for individual income tax returns remains low. In the FY 2024 IRS Data Book, Table 17 reports 0.2 percent examination coverage for Tax Year 2022 individual income tax returns overall, although examination rates vary sharply by income level, return type, and the issues reflected on the return. Self-employed taxpayers, high-income filers, and returns with the characteristics described in this post carry materially higher audit risk than the overall rate suggests.

The most consistently documented audit triggers for small business owners include: unusually high deductions relative to income, claiming 100 percent business use of a vehicle, a home office deduction that does not meet the regular-and-exclusive-use test under IRC Section 280A, consecutive years of business losses that raise hobby loss concerns under IRC Section 183, round-number deductions that suggest estimation rather than actual records, excessive meals and entertainment expenses, cash-intensive operations, and failure to report all income including 1099-NEC, 1099-K, and cryptocurrency proceeds. All 12 are covered in detail in the sections above.

The Discriminant Function System (DIF) is a computerized scoring system used in the IRS examination-selection process as part of the agency’s broader computer screening methods. It assigns a numeric score based on statistical comparisons with similar returns, and the higher the score, the more likely the return is to be flagged for manual review. The IRS does not disclose the exact DIF formula, but a score rises when deductions, income, or other return characteristics deviate significantly from the statistical norm for your income level, industry, and filing status. A high DIF score does not automatically trigger an audit; it causes the return to be reviewed by a human examiner who decides whether a formal examination is warranted.

Under IRC Section 6501, the IRS generally has three years from the due date of the return (or the date it was filed if later) to assess additional tax. However, the statute of limitations extends to six years if the taxpayer omits more than 25 percent of gross income from the return. There is no statute of limitations for fraudulent returns or for returns that were never filed. This means the IRS can audit a return years after it was submitted in certain circumstances, particularly where there is a significant income omission or allegations of fraud.

There are three main types of IRS examinations. A correspondence audit is conducted entirely by mail, typically addressing a single identified issue and requesting documentation to substantiate a particular return item. Correspondence audits represented approximately 77.9 percent of audits closed in FY 2024. An office audit (also called a desk audit) requires the taxpayer or their representative to appear at an IRS office with records. The FY 2024 Data Book classifies the remaining 22.1 percent of closed examinations as field examinations, while IRS publications more broadly describe in-person examinations as occurring at an IRS office, your home, your place of business, or your representative’s office. Despite representing only 22.1 percent of FY 2024 audits, field examinations generated $23 billion of the $29 billion in recommended additional tax for that year.

Do not ignore the notice and do not contact the IRS before consulting with a tax attorney or qualified representative. The IRS sets specific response deadlines, and failure to respond can result in the IRS assessing the full proposed amount without your input. Anything you say to an IRS examiner can be used to expand the scope of the examination. An experienced tax attorney can review the notice, assess the strength of your documentation, identify whether the scope is likely to expand, and represent you throughout the process. See the full discussion in the What to do when you receive an IRS audit notice section above for step-by-step guidance.

Yes. S corporations and LLCs taxed as pass-through entities file their own federal tax returns (Form 1120-S and Form 1065, respectively), and those returns are subject to IRS examination independently of the owners’ individual returns. An audit of the entity return can result in adjustments that flow through to all owners’ individual returns. Additionally, if the IRS is examining a related party (such as a business partner or co-owner), your return may be selected as part of the same inquiry. Entity-level audits of partnerships under the centralized partnership audit regime created by the Bipartisan Budget Act of 2015 and generally effective for partnership tax years beginning in 2018 can result in tax being assessed at the entity level rather than the partner level, which has significant practical implications for partnerships with multiple partners.

Not necessarily. Some returns are selected through random statistical sampling under the National Research Program, and some are flagged by automated systems for items that turn out to be fully substantiated. The FY 2024 IRS Data Book shows that a subset of audits resulted in refunds to the taxpayer. An audit notice is an inquiry, not a determination. That said, IRS examiners are trained to look for issues beyond those initially identified, which is one reason why having experienced legal representation from the very beginning of the process matters. Representation limits the examiner’s ability to expand scope, ensures that documentation is presented in the most defensible manner, and protects your rights throughout the process.

A civil tax audit is an administrative examination of a return conducted by IRS examiners. Its purpose is to determine whether the correct amount of tax was reported and paid. Even if the audit results in a large additional assessment, it remains a civil matter. A criminal tax investigation is conducted by IRS Criminal Investigation (CI) agents and involves an inquiry into whether the taxpayer engaged in willful tax fraud or tax evasion. Criminal investigations can result in federal criminal prosecution, incarceration, and restitution orders, in addition to substantial civil penalties. A civil examination can escalate to a criminal referral if the examiner finds evidence of willful fraud. If there is any possibility of criminal exposure, criminal tax defense counsel should be retained immediately, before making any additional statements to the IRS.