Top 11 common IRS audit triggers: A guide for US expats

For US expatriates, navigating the tax waters can be even more daunting than for stateside citizens.

Understanding the common IRS audit triggers is essential in steering clear of tax woes.

We have carefully compiled a list of 11 red flags that could prompt the IRS to take a closer look at your tax return.

As an American expat, filing your taxes accurately is paramount. Not only do you need to consider US tax laws, but often those of your country of residence as well.

Let's explore the IRS audit triggers to keep you in the clear.

1. Failing to report worldwide income

As an American citizen or green card holder, you are required to report your worldwide income, even if you reside outside the United States.

This includes wages, interest, dividends, and income from investments.

IRS audit red flags: Not reporting foreign bank accounts, omitting income earned outside the US, or not reporting rental income from foreign properties.

Pro tip. Use the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) to potentially lower your tax liability. FEIE can exclude a certain amount of your foreign earned income from US taxation while FTC allows you to offset taxes paid to a foreign government.

2. Discrepancies between reported income and lifestyle

If the IRS notices a significant discrepancy between your reported income and lifestyle, it could raise suspicions.

Expats should be cautious of their spending, especially with credit or debit cards tied to US accounts.

Red flags: Excessive spending in relation to reported income, or making large purchases that are inconsistent with your reported earnings.

Pro tip. Ensure that your reported income reflects your actual earnings and is consistent with your spending patterns. This can be particularly important if you live in a country where living costs are high.

3. Errors in reporting foreign assets and accounts

Expats are often required to file the Report of Foreign Bank and Financial Accounts (FBAR) and/or Form 8938 to report foreign assets if they exceed certain thresholds.

Red flags: Not filing FBAR or Form 8938 when required, providing incomplete or inaccurate information, or underreporting account balances.

Pro tip. Familiarize yourself with the thresholds and requirements for reporting foreign assets and bank accounts, and ensure that all information is accurate and complete.

4. Claiming the foreign earned income exclusion inappropriately

To qualify for the Foreign Earned Income Exclusion (FEIE), you must meet the Physical Presence Test or the Bona Fide Residence Test.

Red flags: Claiming the exclusion without meeting the necessary criteria or making inconsistent claims from year to year.

Pro tip. Maintain accurate records of your physical presence or bona fide residence to substantiate your claim for FEIE.

5. Math errors

Simple mathematical errors can cause discrepancies in your return and inadvertently flag your tax return for review.

Red flags: Miscalculations, transposed digits, inconsistent entries, or failure to report all forms of income.

Pro tip. Double-check all calculations, and consider using tax software or consulting a professional to ensure accuracy.

6. Large charitable donations

The IRS takes notice if the charitable donations you claim are disproportionately large compared to your income.

Red flags: Claiming large charitable donations without proper documentation or donations that significantly reduce your taxable income.

Pro tip. Maintain proper documentation and be reasonable in the amounts you are claiming as donations. Be prepared to substantiate donations if questioned.

7. Home office deductions

Expats working remotely must be cautious when claiming home office deductions.

Red flags: Claiming this deduction without meeting the IRS criteria or making excessive claims for home office expenses.

Pro tip. Ensure your home office is used exclusively for business and keep records of expenses such as rent, utilities, and maintenance. Understand the specific IRS criteria for claiming a home office deduction.

8. Overstating business expenses

For self-employed expats, business expenses can provide valuable deductions. However, exaggerating these claims can draw unwanted attention.

Red flags: Reporting unusually high expenses relative to income or claiming personal expenses as business expenses.

Pro tip. Keep detailed records of legitimate business expenses and be conservative in your claims. Understand the types of expenses that are deductible and the documentation needed to support them.

9. Utilizing aggressive or shady tax schemes

Engaging in aggressive tax avoidance schemes can put you on the IRS radar. These schemes often involve complicated transactions designed to exploit loopholes in the tax code.

Red flags: Using offshore tax havens, engaging in transactions with no economic substance, or participating in schemes that appear to be primarily for avoiding US taxes.

Pro tip. Be transparent in your tax filings and consult with a reputable tax pro to understand the distinctions between tax avoidance and tax evasion. Strive for compliance rather than aggressive minimization.

10. High income

Earning a high income can inherently make you more likely to face an audit. The IRS often focuses on high-income individuals because that's where there are larger amounts of underreported income.

Red flags: Substantially higher income compared to previous years, especially when coupled with aggressive deductions, or having multiple foreign financial accounts.

Pro tip. As a high earner, it’s imperative to keep meticulous records and ensure all reported information is accurate; NOTE - especially for complex international tax scenarios.

11. Inconsistent filing history

Consistency in tax filings is important. The IRS can be alerted to possible issues if your filing history is erratic, particularly when it comes to foreign income and assets.

Red flags: Switching frequently between filing statuses, not filing annually, or inconsistent reporting of similar items from year to year.

Pro tip. Strive for consistency in your tax filings and ensure that you file annually, even if no tax is owed. Keep abreast with changes in tax laws that may affect expats.

Bottom line

Navigating the US tax system as an expat can be daunting. Staying informed about the IRS audit triggers and keeping meticulous records can save you time and stress.

When in doubt, seek advice from a tax pro well-versed in expatriate tax issues. As Benjamin Franklin said - “An investment in knowledge pays the best interest.”