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Why Certain Tax Returns Get Audited by the IRS
The IRS has the authority to audit individual, corporate, and business income tax returns and propose adjustments that may result in additional tax being owed. But why does the IRS audit some returns and not others? Although you may never know the exact reason your return was selected, the following are common issues we see as tax attorneys that often contribute to an IRS audit.
Low Profit Margin or Large Loss on a Business Tax Return
Many audited returns share a similar pattern in the business’s net income. Two scenarios often draw IRS attention:
1. Low Profit Margin
A low profit margin occurs when a business reports minimal net income in relation to its gross income.
Example: A business with $200,000 in gross income and $10,000 in net income has a 5% profit margin.
While some industries naturally operate with low margins, many do not. A consistently low profit margin can appear suspicious to the IRS.
2. Large or Repeated Losses
If a business reports significant losses, especially for multiple years, the IRS may question:
- How the business remains operational
- Whether the returns accurately reflect true income
- Whether the taxpayer can realistically support their lifestyle with such low reported net income
For example, if an individual is the sole shareholder of an S corporation or the sole member of an LLC and consistently reports $10,000–$20,000 of net income, the IRS may question how the individual pays their living expenses. Because net income is typically what the owner uses to support themselves or their family, unusually low income can lead to increased scrutiny.
Large Deductions for Meals, Travel, or Auto Expenses
Many taxpayers mistakenly deduct personal meals, travel, or automobile expenses, assuming they qualify as business deductions.
While ordinary and necessary business expenses can be deducted, these categories are often misunderstood:
- Meals are not deductible simply because someone is “working.” They must have a business purpose, such as a meeting or networking activity.
- Travel expenses may need to be allocated if a trip includes both business and personal activities.
- Automobile expenses must be supported and connected to actual business use.
Excessive or poorly substantiated deductions in these categories commonly result in audits.
Third-Party Reporting
The IRS allows third parties to submit information or reports related to taxpayers who may not be properly reporting income or expenses.
It is commonly said that disgruntled former spouses or employees make up a significant portion of these reports.
Such third-party submissions can trigger an IRS review or audit.
What Happens Once a Return Is Selected for Audit
Regardless of the reason your return was chosen, once you are under audit, the IRS will closely examine the items reported. If you cannot substantiate income, deductions, or positions taken on the return, the IRS is likely to propose an assessment of additional tax.
If you have received an IRS audit notice, you may want to consider speaking with a tax attorney to help you through the audit process. You can discuss your situation with a Columbus tax attorney at The McGuire Law Firm. Contact us today.