Entrepreneur
Key Takeaways
- High-income taxpayers filing Schedule C or claiming aggressive deductions are prime audit targets, so staying accurate and consistent is essential.
- Keeping impeccable records, reporting the right residency and avoiding high-risk strategies can dramatically lower your audit risk.
In 2024, high-income taxpayers were more than twice as likely to be audited compared to previous audit cycles.
What are the most common audit red flags to avoid? Searching for 2025 information online yields little actionable guidance, even in industry journals. There are a host of articles explaining low-income audits, such as those incorrectly filing for the Earned Income Tax Credit. However, middle-class, high-income taxpayers and business owners often struggle to maintain compliance with limited publicly available guidance.
As the CEO of Dimov Tax, I see audit notices every day. From our experience working with thousands of clients, my team and I have identified clear patterns. If you are a high-earning business owner or leader, here are the primary triggers to avoid and strategies to reduce your audit risk.
If you file Schedule C, expect higher scrutiny
Schedule C is the IRS form used by single-member LLCs, sole proprietors, contractors, freelancers and anyone receiving a 1099-NEC. Audit rates are significantly lower for S corporations or C corporations, but Schedule C returns remain prime targets.
Whether your side gig involves legal consulting or you work full-time as a contract telehealth provider, the IRS pays close attention because Schedule C returns are easy to self-prepare. Expense overstatements, often unintentional, are common and frequently trigger audits.
High-review expense categories
Every year, social media influencers promote tax strategies that should be approached cautiously. Past examples include attempts to write off luxury vehicles under the “6,000-pound truck rule” or aggressive real estate syndication deductions, which often ended in audits or lawsuits.
Common expense categories that frequently raise IRS eyebrows include:
- Automotive expenses
- Meals and entertainment
- Rent (studio, vehicle, or office)
- Travel
- Luxury goods
Show a profit two to three years out of five to avoid the “hobby” risk
Consistent losses can trigger the IRS to question whether your business activity is legitimate. A simple rule: your business, freelance, or contract activity should show a profit at least two to three years out of five.
Benchmark your ratios
The IRS compares your expenses and income ratios against industry norms. If a specific line item is far above the historical average, it may flag your return. For example, self-employed consultants with $300,000 in income normally report 15% in software expenses; a 60% software expense could trigger scrutiny.
Importantly, this risk isn’t limited to the ultra-wealthy. Even individuals with modest side gigs, like rideshare drivers, can face audits. Schedule C filers remain a notable exception in audit trends.
Beware of mortgage interest caps
Mortgage interest deductions have caused frequent audit issues. Deductibility depends on when your loan originated:
- Mortgages originated after December 15, 2017: interest is deductible only on up to $750,000 of acquisition debt ($375,000 if married filing separately).
- Mortgages originated on or before December 15, 2017: the prior $1,000,000 limit still applies ($500,000 if married filing separately).
Interest above these thresholds is non-deductible. Review your Schedule A to ensure limits are correctly applied—many IRS notices are triggered by this issue.
Take appropriate real estate losses against W-2 income
Social media strategies often suggest high-paid W-2 earners can reduce taxes by purchasing properties for short-term rentals and claiming large depreciation deductions. Others suggest claiming “real estate professional” status to offset W-2 income.
Even if these strategies are valid, the IRS scrutinizes them closely. Cost segregation, accelerated depreciation and bonus depreciation strategies require meticulous documentation.
Residency pitfalls: addresses, withholding and multi-state filing
Remote work and increased mobility have made state tax filings more complicated than ever. Using the wrong address on a W-2, 1099 or other forms can trigger significant tax liabilities.
Common scenarios we see include:
- Using a parent’s or friend’s address while working remotely.
- Receiving mail at a P.O. Box or a previous residence.
- Keeping an old address on employer records after relocating.
Even seemingly small mistakes can have major consequences. When a state sees income linked to an address within its jurisdiction, it can pull your full federal transcript and attempt to tax all income earned across every location — sometimes resulting in six-figure tax bills.
Tips to avoid costly errors:
- Confirm your correct state of residence and review all employment and financial records.
- Double-check addresses on all W-2s, 1099s, and other tax forms.
- Monitor pay stubs throughout the year. Taxpayers sometimes pay the wrong state for months—or even the full year—with no easy recourse. In one case we handled, a taxpayer accidentally paid $200,000 in state taxes that could not be recovered.
If there’s any chance a form or income source is associated with a state where you no longer live, contact your tax professional immediately to review corrective actions and prevent unnecessary liabilities.
High-risk strategies flag your return
Certain niche strategies carry higher audit risk, including:
- Conservation easements
- Captive insurance companies
- Charitable contribution schemes
- Complex insurance or trust structures
These strategies often result in audits that are upheld, leading to penalties, back taxes and professional fees. Always consult a neutral, experienced tax professional before pursuing these approaches.
Conclusion
Being audited is not inevitable. Filing an extension may reduce your risk because the IRS fills its audit quota early in the year. Filing later after making estimated payments may reduce the likelihood of being flagged.
Meticulous documentation, accurate reporting and professional review are the most reliable ways to reduce audit risk.
Key Takeaways
- High-income taxpayers filing Schedule C or claiming aggressive deductions are prime audit targets, so staying accurate and consistent is essential.
- Keeping impeccable records, reporting the right residency and avoiding high-risk strategies can dramatically lower your audit risk.
In 2024, high-income taxpayers were more than twice as likely to be audited compared to previous audit cycles.
What are the most common audit red flags to avoid? Searching for 2025 information online yields little actionable guidance, even in industry journals. There are a host of articles explaining low-income audits, such as those incorrectly filing for the Earned Income Tax Credit. However, middle-class, high-income taxpayers and business owners often struggle to maintain compliance with limited publicly available guidance.
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