Why Did the IRS Pick Me for an Audit?

While most IRS audits are standard civil examinations, the risk increases substantially when the review involves specific high-risk areas such as underreported income, cryptocurrency, offshore accounts, cash businesses, large deductions, payroll issues, or multi-year discrepancies. Taxpayers often assume their return was “randomly selected,” but this is rarely the case; your selection was triggered by statistical drivers pointing to a specific reason for scrutiny. Successfully navigating this process requires understanding several key factors:

• Why your return triggered scrutiny
• What the IRS already knows about you
• How IRS examiners detect fraud
• How and when audits turn criminal
• How CPAs and taxpayers must behave to avoid obstruction
• What a tax attorney can do to keep the case civil

📘 References:

• The IRS Examination Process
• Understanding your CP2000 series notice
• IRS Publication 556 – Examination of Returns
• IRS Criminal Investigation (CI) Overview
• IRS Fraud Handbook (IRM 25.1)

What an IRS Audit Really Is (And Why It’s Dangerous)

Many taxpayers mistakenly view an IRS audit as a simple request for documents, but it is actually a legal investigationauthorized under IRC §7602. This statutory authority grants the IRS significant power, making the process potentially dangerous.

During an audit, the IRS has the authority to:

• Demand records
• Conduct interviews
• Issue administrative summonses
• Contact third parties (like your bank, employer, or vendors)
• Reconstruct income using indirect methods
• Assert civil penalties
• Refer the case to IRS Criminal Investigation (CI)

Even an audit that starts as a civil matter can swiftly escalate to a criminal one if the IRS examiner detects indicators of fraud. Since examiners are explicitly trained to look for these fraud indicators, understanding why your return was selected for audit is absolutely critical to managing your risk.

📘 References: IRC §7602 – Examination of books and witnesses

The Most Common IRS Audit Triggers

Even if your tax return doesn’t contain an obvious “red flag,” it may be statistically anomalous compared to similar returns. However, the following specific items are known to significantly raise audit risk.

🎯 Underreported Income

Unreported income is a cause of audits. The IRS uses sophisticated matching and analytical programs to compare your reported income against various data sources, including:

• Industry Norms: Comparing your business income to similar businesses.
• Prior Years: Looking for unexplained, significant dips or changes in income.
• Bank Deposits: Analyzing deposits that exceed reported income (indirect methods).
• Information Returns: Direct matching against 1099s, W-2s, 1099-Ks, and other third-party reporting.
• Known Cash-Flow Indicators: Data suggesting a lifestyle or spending inconsistent with reported income.

🎯 Excessive Deductions vs. Income

A classic red flag is high deductions that appear disproportionate to the gross income reported on the return. High-risk examples include:

• Large Charitable Contributions: Especially non-cash contributions requiring strict appraisal and documentation.
• Business Losses (Especially Repeated): Consecutive losses from a business activity may trigger “hobby loss” scrutiny under IRC §183.
• High Travel and Meals Deduction: Requires strict substantiation under IRC§274(d).
• Home Office Deduction Irregularities: Misuse of this deduction for space not used exclusively and regularly for business.

📘 References: IRS Publication 5558 – Activities Not Engaged in for Profit: Audit Technique Guide

🎯 Schedule C Filers (Sole Proprietorships)

The Schedule C (Profit or Loss From Business) is the most highly audited type of tax return because it lacks the third-party income verification of a W-2. High-risk factors include:

• Cash Businesses: Where income recording is easily manipulated.
• Round Numbers: Using round figures for expenses, suggesting estimation rather than actual tracking.
• Low Gross Receipts: Returns reporting minimal activity but high expenses.
• Losses Year After Year: Strong indication of a hobby or non-profit seeking activity (IRC §183).

📘 References: About IRS Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship)

🎯 Cryptocurrency Reporting

The IRS treats crypto as property and aggressively enforces compliance. Audit triggers include:

• 1099-B/1099-K Triggers: Mismatches between reported gains/losses and forms issued by exchanges and crypto platforms.
• Inconsistent Reporting: Failing to account for all taxable events (e.g., selling, trading, using crypto for payment).
• Form 1040 Crypto Question: Answering the “virtual currency” question on the Form 1040 incorrectly (lying can be a criminal trigger).

📘 References: IRS Crypto Enforcement

🎯 Foreign Accounts (FBAR & FATCA)

Failure to disclose foreign bank accounts and assets is subject to heavy civil and potentially criminal penalties.

• FBAR: IRC §5314 is the legal basis for the Report of Foreign Bank and Financial Accounts (FBAR) requirement, which mandates that certain U.S. persons report their financial interests in foreign accounts to the U.S. government
• FATCA: IRC §6038D, part of the Foreign Account Tax Compliance Act (FATCA), mandates that certain U.S. taxpayers disclose their interests in “specified foreign financial assets” when the total value of these assets surpasses specific thresholds.

🎯 Large Refund Claims / Credits

Returns claiming large refunds or specific refundable tax credits are frequently flagged, often triggering a pre-refund audit or mandatory review.

• High-Risk Credits: Earned Income Tax Credit (EITC) and Additional Child Tax Credit (ACTC) are subject to significant compliance checks.
• Fuel Credits: Historically scrutinized for misuse.
• Amended Returns (Form 1040-X): Filing an amended return claiming a very large refund frequently initiates an examination.

Types of IRS Audits (And What They Mean)

The severity and scope of an audit are defined by the type of examination initiated.

📘 References: IRS Audits

The Reverse Audit – When the IRS Knows More Than You Think?

A “reverse audit” is a particularly dangerous scenario where the IRS examiner is already suspicious of tax wrongdoing but intentionally does not reveal that suspicion to the taxpayer or their representative.

• The Deception: The examiner may appear friendly and questions may seem routine, leading the taxpayer/CPA to believe the case is a simple civil matter.
• The Reality: The examiner is actually implementing a quiet strategy, meticulously documenting indicators of intent and collecting evidence to build a case for potential fraud.
• Warning Signs: Unexplained silence, excessive delays, or vaguely worded information requests may signal that the case is in the early stages of fraud development.

Reverse audits are highly risky because:

• The taxpayer, unaware of the criminal exposure, may speak too freely and self-incriminate.
• The CPA may accidentally provide harmful documents that aid the IRS’s criminal case.
• The IRS quietly builds a fraud case before initiating an abrupt referral to Criminal Investigation (CI) without warning.

When an IRS Audit Can Turn Criminal?

A civil audit is a minefield because the civil auditor is required to refer suspicious cases to IRS Criminal Investigation (CI) under IRM 25.1.3 (Fraud Referrals) if they find evidence of willful fraud. Criminal triggers (“Badges of Fraud”) (IRM 25.1.2.3 (11-03-2023)) include, to name a few:

• Unreported Offshore Accounts
• Fake Documents or Receipts (evidence of lying/fabrication)
• False Deductions (claiming non-existent business expenses)
• Large Cash Transactions / Structuring (breaking up deposits to avoid reporting thresholds)
• Failure to File for multiple consecutive years.

There are warning signs your audit is turning criminal. The biggest danger is not disclosed to the taxpayer. Be alert if the examiner:

• Communication unexpectedly freezes or the examiner becomes evasive.
• Stops asking routine questions and focuses on intent.
• Requests a Bank Deposit Method Analysis (an indirect method of income reconstruction).
• Wants to interview you without your tax attorney present.

💡Crucial: Never attend an audit interview alone.

How to Reduce Your Audit Risk Going Forward?

Proactive compliance is the best defense against an audit.

• Reconcile All 1099s & W-2s: Verify all income reported by third parties before filing.
• Maintain Contemporaneous Records: Keep detailed, organized records as transactions occur.
• Avoid Round Numbers: Use exact figures for expenses to demonstrate true record-keeping.
• Document Business Purpose: Clearly justify the necessity of all business expenses.
• Track Crypto Trades & Basis: Keep meticulous records of all crypto capital gains and losses.
• Report All Foreign Accounts: Strictly comply with FBAR and FATCA reporting.
• File and Pay Timely: Avoid simple late-filing penalties.

When to Hire a Tax Attorney?

The most critical time to hire a tax attorney is immediately—ideally before you have any contact with the IRS, including the first interview, document submission, or even the initial phone call.

Early intervention by legal counsel is essential because attorneys can:

• Evaluate Criminal Risk: Conduct a privileged internal review to assess the potential for the audit to escalate from civil to criminal.
• Control Communications: Become the sole point of contact for the IRS, preventing you from making damaging, on-the-record statements.
• Shield the CPA: Protect your accountant from inadvertently incriminating you and potentially shield the CPA’s work product via the Kovel doctrine.
• Protect Privilege: Ensure that sensitive discussions and internal audit findings remain protected by the attorney-client privilege.
• Prevent CI Referral: Implement a strategy designed to mitigate fraud indicators, thus reducing the risk of a referral to Criminal Investigation (CI).
• Manage FTA Involvement: Intervene strategically when a Fraud Technical Advisor (FTA) is involved, signaling heightened internal scrutiny.
• Build a Civil-Only Resolution Strategy: Negotiate a settlement or resolution that keeps the focus strictly on civil tax liabilities and penalties.

The earlier experienced counsel intervenes, the dramatically higher the chance of keeping the case non-criminal and survivable.

📘 References: Form 2848 – Power of Attorney

Facing an IRS Audit? Pelham PLLC Protects You From the First Notice Through Final Resolution.

If you received a CP2000, Letter 566, Letter 525, Letter 2205, or any formal audit notice, you need experienced tax defense counsel immediately. IRS auditors are trained to expand audits, assess penalties, and identify fraud indicators. Your first response matters.

Pelham PLLC represents taxpayers nationwide in:

• IRS audits
• IRS Appeals
• Tax Court litigation
• Criminal tax investigations
• DOJ tax prosecutions
• Offshore and crypto tax matters

Contact Pelham PLLC today for a confidential audit defense consultation. Your rights—and your financial future—depend on early intervention.

FAQs

Why was my return selected for audit?

Most often due to mismatched information (CP2000), a high DIF score (statistical anomaly), or excessive deductions.

Can the IRS audit multiple years?

Yes. The statute of limitations is typically 3 years, but it extends to 6 years for gross income omissions greater than 25% and is unlimited for fraud.

Can an audit turn criminal?

Yes—especially when indicators of willful intent, such as unreported offshore accounts, false documents, or failure to file, are present.

Should I talk to the IRS myself?

Never. Anything you say becomes evidence in the case file.

Can an attorney keep the case civil?

Often, yes. Early intervention allows counsel to control disclosures, prevent intent-based questioning, and manage the risk of a CI referral.