Top 10 IRS Red Flags to Avoid in 2025

As tax laws evolve and enforcement technology advances, staying compliant requires awareness and proactive planning. The IRS continues to refine its audit selection process, focusing on specific risk areas through data matching and automation. For the 2025 filing season, here are the key red flags that could draw unwanted IRS attention—and practical steps to avoid them.

1. Mismatched or Missing 1099/W-2 Income
The IRS receives copies of every 1099 and W-2 you do. Their Automated Underreporter (AUR) system instantly flags discrepancies.
✅ Avoid it: Reconcile all income documents before filing. If you’re a freelancer or contractor, report all 1099 income—even if you didn’t receive a form.

2. Excessive Business Deductions Relative to Income
High deductions on Schedule C, especially in cash-intensive industries (e.g., restaurants, rideshare, creative services), are closely scrutinized.
✅ Avoid it: Maintain impeccable records (receipts, logs, and bank statements). Ensure deductions are both ordinary for your industry and necessary for your business.

3. Misclassifying Workers as Independent Contractors
The IRS and Department of Labor are aggressively targeting worker misclassification to recover unpaid payroll taxes.
✅ Avoid it: Use the IRS 20-factor test or Form SS-8 for guidance. When in doubt, a reasonable salary through a W-2 is safer than risking penalties.

4. Large Charitable Deductions Without Proper Documentation
Substantial non-cash donations or cash gifts exceeding normal income percentages can trigger reviews.
✅ Avoid it: Always obtain a written acknowledgment for donations over $250. For non-cash gifts over $500, file Form 8283. For items valued over $5,000, get a qualified appraisal.

5. Home Office Deduction Errors
The simplified ($5 per sq. ft.) and regular methods are often misapplied, especially if the space isn’t used exclusively and regularly for business.
✅ Avoid it: Keep a floor plan and photos. If using the regular method, meticulously allocate mortgage interest, utilities, and repairs.

6. Cryptocurrency & Digital Asset Transactions
The IRS now includes a digital asset question on Form 1040. Failing to report crypto trades, mining, or NFT sales is a high-risk omission.
✅ Avoid it: Use a crypto tax software report or professional service to calculate gains/losses. Every exchange is reportable.

7. Foreign Account & Asset Non-Reporting
With FATCA and global data-sharing, undisclosed foreign accounts (FBAR - FinCEN Form 114) or foreign assets (Form 8938) carry severe penalties.
✅ Avoid it: If your foreign accounts exceed $10,000 at any point in the year, file an FBAR. For larger assets, consult an international tax specialist.

8. High Earners Not Filing or Underpaying
Taxpayers with income over $1 million are audited at significantly higher rates. The IRS also targets income disparities between federal returns and third-party reports.
✅ Avoid it: Ensure quarterly estimated tax payments are accurate. File timely, even if you must request an extension to pay.

9. Excessive Energy Credits Without Qualification
Clean vehicle (Form 8936) and home energy (Form 5695) credits are under review. Claiming ineligible property or exceeding phase-out limits will trigger correspondence audits.
✅ Avoid it: Verify that vehicles and home improvements meet IRS eligibility requirements. Keep all manufacturer certifications.

10. Rounded Numbers & Sloppy Math
Consistently rounded numbers (e.g., $5,000 exactly for meals, $500 exactly for office supplies) suggest estimation rather than precise record-keeping.
✅ Avoid it: Report exact figures from your records. Use accounting software to track expenses in detail.

How the IRS Flags Returns

Understanding their methods helps you stay compliant:

Discriminant Inventory Function (DIF) Scoring: An algorithm compares your deductions to norms for your income bracket and profession.

Third-Party Data Matching: The IRS cross-references your return with forms from employers, banks, brokers, and payment apps.

Related Examinations: If a business partner or client is audited, your return may be pulled for review.

Whistleblower Tips: The IRS Whistleblower Office pays incentives for reports of substantial tax evasion.

Proactive Measures for 2025

Digitize Your Records: Use apps to capture receipts and log mileage in real time.

Reconcile Early: Match all 1099s, 1098s, and 1095s before your accountant files.

Consult a Professional: Before filing, discuss any complex transactions (crypto, foreign income, large deductions) with a tax advisor.

File Electronically: E-filed returns have a lower error rate than paper returns.

Don’t Overreact: Legitimate deductions should still be claimed—just keep perfect documentation.

Bottom Line: The best audit defense is accurate reporting and organized documentation. If you’re uncertain about a deduction or reporting requirement, seeking professional guidance is a wise investment in your peace of mind.

Stay ahead of IRS scrutiny. Let Prestivo Tax LLC help you navigate the 2025 filing season with confidence and compliance.