The word “audit” has a way of tightening shoulders. The tension-relieving truth? The vast majority of returns aren’t audited. And when the IRS (or “the Service”) does reach out, it’s usually because something didn’t match: a form the Service already has on file, a number that looks out of step, or a pattern that needs a little explanation.

Every W-2 and 1099 is sent to the IRS before it ever hits your mailbox. The Service uses technology to compare what you filed to what third parties reported — and to statistical norms for similar taxpayers. If the numbers don’t correspond, you might see a notice (often a simple mismatch letter). Less commonly, you’ll find an audit request in your inbox.

Of course, a mismatch letter can escalate to a full-on audit, especially if your tax file shows a history of negligence, fraud, noncompliance, or indicates risky tax strategies or those that have not been fully maintained.

Below, you’ll find a few of the signals that most often draw IRS scrutiny — and, more importantly, the simple moves that can keep your tax return’s audit risk low.

Picking The “Already Risky” Advanced Tax Strategies

Many taxpayers are surprised to know that some tax moves are under the spotlight from the start. The IRS maintains categories like “listed transactions” and “transactions of interest” for certain high-risk tax moves, and there’s a broader bucket of strategies that, while not always formally listed, still tend to draw scrutiny.

Common examples include:

• Syndicated conservation easements, where investors pool funds to invest in land for easement benefits and claim deductions far in excess of what they put in.
• Unconventional trust arrangements that are used to shield otherwise taxable income, pay otherwise unallowable expenses tax-free, or that are consistently non-complaint.
• Film, oil, and carbon credits and deductions, where the usage heavily depends on the taxpayer’s active or passive status in the flow-through entity.
• Valuation-discount Roth conversions that move minority, non-marketable partnership interests into a Roth at steep appraisal discounts with the expectation of lower-cost, tax-free growth.
• Aggressive depreciation strategies without clear, defensible documentation that the taxpayer is eligible to take the deduction.

While many tax strategies may be “born” in a page of the IRS tax code, some are frequently abused, oversold, or improperly managed in practice, which can lead to further review by the IRS or a state agency.

When it comes to an advanced tax strategy, it’s best to act with precaution. Discuss your plan with your trusted team of advisors who can help you conduct some research on the strategy — including the IRS’s feelings about it.

Not Growing Your Tax Habits As Your Income Grows

At the start of most careers, a tax return is usually fairly simple: a W-2, a few deductions, maybe some interest income from your local credit union. As income grows, the return starts to look more like a small ecosystem: incentive stock options (ISOs), a portfolio of rental units, an S-Corp with a retirement plan attached, 529 plans for the children, cryptocurrency and a revocable living trust.

This is when the IRS starts to pay closer attention.

While the government rewards financial involvement in the economy by allowing tax deductions, subsidizing credits, and allowing other special tax treatment, the IRS still keeps a keen eye open to ensure everything in your “ecosystem” is above-board.

When things start to get a bit more complex, be sure you — and your advisor — have a full understanding of where your tax obligations lie and what triggers them. Once you understand your obligations relative to your assets and income, you may find that it’s easier to keep tabs on the recordkeeping you’ll need to support your tax positions, allowing for a more defensible audit trail (and, by extension, better planning opportunities).

Businesses That Don’t Show A True Profit Motive

Though the IRS is usually patient for a few years during the start-up phase, a business reporting losses year-over-year without showing any substantial profit is always a major red flag.

Long-running losses can signal a potential hobby loss or tax shelter in the eyes of the IRS. And if the IRS decides your “business” has no profit motive, it can disallow prior-year losses and recompute the tax as if those deductions never happened.

To derisk, always consider consulting with your tax advisor before engaging in business activity. Making the right move up front can save you from a surprise tax bill down the line when you least expect it.

At Felton & Peel, we understand that when it comes to audits, penalties, and “too good to be true” strategies, awareness is half the battle. Our goal is to help families recognize their tax obligations and realize the need for administrative planning and maintenance to ensure they remain in compliance. We’re here to help — and your first consultation is on us.

Please consult with your tax advisor before moving forward with any tax-related strategies.