Personal Finance
These red flags can trigger an IRS tax audit, experts say
Maria Korneeva | Moment | Getty Images
As millions of taxpayers file returns, many worry that certain claims could boost their chances of being picked for an IRS audit.
After an infusion of funding, the agency said it aimed to more than double the audit rate for the wealthiest taxpayers. But the IRS’ future priorities are unclear amid changing leadership and a Republican-controlled Congress and White House.
Still, some areas can be “low-hanging fruit for the IRS,” said Mark Baran, managing director at financial services firm CBIZ’s national tax office.
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Regardless of your income, you shouldn’t round numbers or estimate expenses on your return, Baran said.
“You’re really playing the audit lottery and increasing your risk,” he said.
Here are some other common IRS red flags for audit, according to some tax experts.
Underreported income
The IRS often finds missing income via so-called “information returns,” or tax forms, which employers and financial institutions send to taxpayers and the agency.
For example, these could include Form W-2 for wages, 1099-NEC for contract or gig economy work or 1099-B for investment earnings.
IRS software compares these tax forms to your return, and it can be “flagged for audit” when there’s a mismatch, explained Elizabeth Young, director of tax practice and ethics for the American Institute of Certified Public Accountants, or AICPA.
High deductions compared to earnings
Another area for IRS scrutiny can be high tax breaks compared to your income, Baran said.
The agency has a program that compares your return to others in a similar tax bracket, he said. The software uses an algorithm to determine whether your deductions are higher than average.
For example, if your charitable deduction is 30% to 50% of your adjusted gross income, that could prompt “another set of eyes,” Baran said.
Earned income tax credit
Another common target is the earned income tax credit, or EITC, a refundable tax break for low- to moderate-income workers, experts say.
“There are people who claim it improperly for one reason or another,” said Syracuse University law professor Robert Nassau, director of the school’s low-income tax clinic. “It can be confusing,” with eligibility based on earnings, residency and family size.
Higher earners are more likely to face an audit, but EITC claimants have a 5.5 times higher audit rate than the rest of U.S. filers, partly due to improper payments, according to the Bipartisan Policy Center.
‘Substantiation’ can protect from audits
While there are red flags, IRS audits are still relatively rare.
Through fiscal year 2023, the IRS examined 0.44% of individual returns filed for tax years 2013 through 2021, according to the latest IRS Data Book.
When audits involve “mistakes or innocent omissions,” they are typically conducted via so-called “correspondence audits,” which happen by mail, Baran said.
More than 77% of fiscal year 2023 audits occurred via correspondence, the IRS reported. The remaining were face-to-face “field” audits.
Either way, filers with “substantiation really should not fear,” said Baran, noting the importance of receipts and other records to support claims on your return.
“The IRS knows when somebody is prepared and they will move on,” he said.
Martin Barraud | Ojo Images | Getty Images
As U.S. home equity climbs, owners are more likely to face capital gains taxes from selling property. But a lesser-known tax strategy could help shrink your bill, experts say.
When selling your main home, there’s a special tax break that shields up to $250,000 of profits for single filers and $500,000 for married couples filing jointly. However, you need to meet certain rules.
An increasing number of home sellers are exceeding those thresholds, according to a 2024 report from real estate data firm CoreLogic. Nearly 8% of U.S. homes sold in 2023 exceeded the capital gains tax limit of $500,000 for married couples, up from about 3% in 2019, the report found.
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Those percentages were even higher in high-cost states like Colorado, Massachusetts, New Jersey, New York and and Washington, according to the CoreLogic report.
Exceeding the $250,000 and $500,000 exclusions is “becoming more common,” said Tommy Lucas, a certified financial planner and enrolled agent at Moisand Fitzgerald Tamayo in Orlando, Florida.
Home sale profits above the $250,000 or $500,000 thresholds are subject to capital gains taxes of 0%, 15% or 20%, depending on your taxable income.
Increase your ‘basis’ to reduce profits
Many home sellers don’t realize they can reduce capital gains by increasing their “basis,” or the home’s original purchase price, according to Mark Baran, managing director at financial services firm CBIZ’s national tax office.
You can increase your basis by adding “capital improvements,” such as renovations, adding a new roof, exterior upgrades or replaced systems.
Your “adjusted basis” is generally the cost of buying your home plus any capital improvements made while you own the property.
“That adds up over time and can bring them fully within the [$250,000 or $500,000 capital gains] exclusion,” Baran said.
However, you cannot add home repairs and maintenance, such as fixing leaks, holes, cracks or replacing broken hardware, according to the IRS.
You also can reduce your home sale profit by adding fees and closing costs from the purchase and sale of the home, according to Lucas.
The IRS says some of these expenses could include:
- Title fees
- Charges for utility installation
- Legal and recording fees
- Surveys
- Transfer taxes
- Title insurance
- Balances owed by the seller
“Maybe that gets you an extra few thousand” to reduce the profit, Lucas added.
Traders on the floor of the New York Stock Exchange at the opening bell in New York City on Feb. 12, 2025.
Angela Weiss | Afp | Getty Images
Stock market investors enjoyed lofty annual returns over the past two years. However, 2025 may not offer a “three-peat,” investment analysts say.
The S&P 500 stock market index yielded a 23% return for investors in 2024 and 24% in 2023. (Those returns were 25% and 26%, respectively, with dividends.)
Three consecutive years of total returns of more than 20% for U.S. stocks is a historical rarity. It has only happened once — in the late 1990s — dating back to 1928, according to Scott Wren, senior global market strategist at the Wells Fargo Investment Institute.
“Do we expect an S&P 500 Index three-peat in 2025? In short, no,” Wren wrote in a market commentary Wednesday.
The U.S. stock market has delivered average annual returns of roughly 10% since 1926, according to Dimensional, an asset manager. After accounting for inflation, stocks have consistently returned an average 6.5% to 7% per year dating to about 1800, according to a McKinsey analysis.
“We have been spoiled as investors” the past two years, said Callie Cox, chief market strategist at Ritholtz Wealth Management.
“Twenty-percent gains haven’t been the norm,” Cox said. “Twenty percent gains are the exception.”
What might ruin the party?
While history “isn’t gospel,” there are reasons to think the stock market may not perform as well in 2025, Cox said.
For one, there are many uncertainties that could negatively impact the stock market, including tariffs and a potential rebound in inflation, Wren said. A surge in bond yields might also pose a headwind, Wren wrote in a market commentary. (Higher yields could dampen demand for U.S. stocks.)
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Additionally, technology companies have been a major driver of S&P 500 returns in recent years but may not be poised for the same outperformance this year, Cox said.
Tech stocks suffered a rout in late January, for example, amid fears of a Chinese artificial intelligence startup called DeepSeek undercutting major U.S. players. Those stocks have largely recovered since then, however.
In all, a rosy backdrop of solid economic growth and consumer spending, coupled with relatively low unemployment, may push the S&P 500 up by about 12% in 2025, Wren wrote. That would be slightly better than the long-term historical average, he said.
“So do not be disappointed,” Wren wrote. “We think investors should be optimistic.”
However, investors shouldn’t let high expectations cloud judgment about market risks, Cox said.
The current environment is one in which investors should “prioritize portfolio balance” and long-term investors should ensure their portfolio is in line with their targets, she said.
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