How far back can IRS audit: Common audit triggers

Taxpayers, especially US expats, often stress about tax audits because they have no idea what years can the IRS audit their filed (or, sometimes - NON-filed) tax returns.

So, how far back can the IRS audit?

The simple answer is - it depends on your specific scenario. If you have fulfilled the FBAR (foreign bank accounts reports) reporting requirements up till now then the IRS has 3 years to audit your expat returns. If it’s not up to date then the 3 years are extended to 6 years.

However, there are exceptions. The IRS audit statute of limitations ceases to apply and the period of audit can become indefinite if you:

• Have never filed a tax return;
• Forgot to sign your tax return;
• Filed fraudulent returns in the past.

In this article, we are going to mainly look at audit triggers as well as what happens if you get audited.

Understanding the standard IRS audit timeframes

When it comes to IRS audits, time is of the essence – both for the IRS and for taxpayers.

The IRS operates within specific audit timeframes, known as the statute of limitations, which dictate how far back they can review a tax return.

Let’s break down the two primary timeframes:

1. The three-year rule

The most common timeframe for an IRS audit is three years from the date you file your tax return.

This means:

• If you filed your 2022 return on April 15, 2023, the IRS typically has until April 15, 2026, to initiate an audit.
• This three-year window applies to most taxpayers whose returns are accurate and complete.

Why three years? This period balances the need for the IRS to ensure compliance with taxpayers' rights to finality and closure.

2. The six-year rule

If a taxpayer underreports their income by more than 25%, the IRS can extend the audit window to six years.

For example:

• If you report $80,000 in income but the IRS later discovers your income was actually $110,000 (more than 25% underreported), the six-year rule applies.
• The six-year rule also covers certain omissions, such as foreign income exceeding $5,000 that wasn’t reported.

✔️Pro tip: Even unintentional underreporting can trigger this extended timeframe, so accuracy is critical when filing your return. Remember! Good record-keeping is your best defense!

When IRS audits can last indefinitely

While the IRS typically operates within specific timeframes for audits, there are situations where the audit window remains open indefinitely. These scenarios underscore the importance of filing accurate and timely returns.

1. No return filed

If you fail to file a tax return, the IRS has no statute of limitations for initiating an audit. Unlike cases where a return has been filed, failing to file provides the IRS with an unlimited timeframe to assess taxes, penalties, and interest.

Why is this significant?

• The absence of a filed return means the IRS can revisit your financial records at any point in the future.
• This situation is particularly risky for individuals with substantial income or assets that are visible through third-party reporting (e.g., 1099s, W-2s).

✔️Pro tip: Always file a tax return, even if you can’t pay the taxes owed. Filing protects you from indefinite audits and allows you to negotiate payment arrangements if needed.

2. Fraudulent activity

When fraud or intentional tax evasion is involved, the IRS can audit your returns without any time limit.

This includes actions such as:

• Deliberately omitting income.
• Claiming false deductions or credits.
• Manipulating records to evade taxes.

Why is fraud treated differently? Fraud undermines the integrity of the tax system, and the IRS prioritizes addressing deliberate noncompliance.

Why can I be selected for an audit?

An IRS audit is a detailed review of a taxpayer's return to ensure that the information filed aligns with tax laws.

While audits may sound intimidating, understanding the common triggers can help you file accurate returns and minimize your audit risk.

Here’s a breakdown of the most common reasons the IRS may decide to take a closer look at your taxes:

1. Random selection through computerized screening

The IRS employs a computerized scoring system, known as the Discriminant Information Function (DIF), to identify potentially problematic returns.

• How it works: The system compares returns to statistical norms. Returns that deviate significantly from these norms are flagged for further review.
• What this means for you: Even a well-prepared return can be selected purely by chance if it appears unusual based on IRS data models.

2. Connections to audited individuals or entities

If you have ties to someone under audit – such as a business partner, spouse, or shareholder in the same company – you may also come under scrutiny.

3. High income levels

The higher your income, the greater the likelihood of an audit. The IRS tends to focus more resources on wealthier taxpayers due to the potential for larger discrepancies.

Recent audit trends: Here’s a snapshot of audit rates for taxpayers with significant income (Tax Year 2019, as of May 2022):

TPI defined: TPI includes all positive income sources, excluding losses.

4. Large or unsubstantiated charitable donations

While charitable giving can lower your tax liability, donations that appear excessively large in proportion to your income may raise red flags.

Key points:

• Cash donations are easily traceable via bank records.
• Donations of property require a fair market value assessment, which must be documented thoroughly.

✔️Pro tip: Always retain receipts, appraisals, and records for all donations to support your claims.

5. Mathematical or clerical errors

Even minor arithmetic mistakes can flag your return for review.

Why this matters: errors, whether intentional or accidental, suggest inaccuracies that could require correction or verification.

✔️Pro tip: Use tax software or work with a tax professional to ensure your return is error-free.

6. Being self-employed

Self-employed individuals often face higher scrutiny due to the flexibility of reporting income and deductions. Key areas of concern include:

I. Excessive deductions

Watch out for: 

• large home office deductions,
• significant meal expenses,
• vehicles listed as exclusively business use.

✔️Pro tip: Ensure deductions meet the IRS criteria for "ordinary and necessary" business expenses.

II. Misclassification of workers

Independent contractors vs. employees: Misclassifying employees as contractors to avoid payroll taxes can trigger audits.

Solution: Follow IRS guidelines to ensure proper classification.

III. Cash-intensive businesses

Businesses like restaurants or convenience stores that deal heavily in cash are more likely to face audits due to the risk of underreporting income.

IV. Continuous business losses

Why it matters: Repeated losses over multiple years can prompt the IRS to investigate whether your activity qualifies as a business or a hobby.

NOTE! Hobby-related expenses are not deductible, unlike legitimate business losses.

7. Claiming the Earned Income Tax Credit (EITC)

The EITC, designed to help low- to moderate-income families, is one of the most commonly flagged areas due to errors.

Why? The IRS estimates that about 50% of EITC claims contain inaccuracies, whether due to misunderstanding eligibility or intentional misreporting.

8. Unexplained revenue or expense changes

Significant year-over-year changes in income or expenses without a clear explanation can attract attention.

✔️Pro tip: Be prepared to provide explanations and documentation for any major fluctuations in your financial statements.

How will the IRS conduct my audit?

The IRS will initially get in touch with you by mail which will contain all the guidelines and contact information. Generally, your audit may fall into one of these categories:

• Correspondence audits. The IRS will conduct correspondence audits via mail or electronically. It involves reviewing specific items on your tax return. The IRS will request the necessary documents and will give you reasonable time to respond to their request.
• Office audit. In an office audit, you are required to meet the IRS auditor at a local IRS office. The auditor will review your records along with all the supporting documentation. You may be asked to provide additional information.
• Field audit. In a field audit the IRS auditor will visit your business location or residence to review a wide range of records and documents such as bank statements, financial statements, receipts, and invoices. They may ask you for additional information.

What do I need to provide during an audit?

The IRS will send you a list of required documents for audit in writing. They might ask you to provide the following documentation to support your reported income, claimed deductions, and credits:

• Receipts with dates & notes on their purpose and how it is related to your business;
• Bills mentioning the payment dates & the name of the receiver;
• Canceled checks;
• Legal documents.

To make sure that the IRS received every correspondence and sent documents you can request confirmation from your delivery services.

NOTE! Taxpayers often wonder “how many years of tax returns to keep”.  The law requires you to keep the records of documents for at least 3 years.

How far back can the IRS audit past tax returns?

This mostly varies on a case-to-case basis. As a general rule, the IRS can audit returns filed within 3 years.

The 3 years become 6 years when the IRS finds the omission of more than 25% of gross income.

Also (did you know?):

• How far back can the IRS go for unfiled taxes? - Forever! If an auditor encounters omissions of tax forms or suspects fraud the statute of limitation is no longer applicable and they can audit your returns indefinitely.
  This can lead to the IRS imposing heavy penalties on you.
• How long it takes to conclude an audit? - It may take a few months to a year depending on the complexity, availability of the required documents, and the type of audit.

Record-keeping recommendations

Good record-keeping is your best defense against an audit.

The IRS expects taxpayers to substantiate their income and deductions with appropriate documentation.

Here’s what you need to know:

• How long to keep records: Retain tax-related documents for at least seven years, especially if there’s a chance of underreporting income or claiming complex deductions.
• What to keep: Save receipts, invoices, bank statements, charitable donation records, and any documentation related to income, credits, and deductions.

✔️Pro tip: Organize your records by year and category to simplify retrieval in case of an audit.

Recent IRS enforcement trends

The IRS has recently increased its focus on auditing high-income individuals and businesses with complex financial arrangements.

With additional funding and resources, the agency has expanded its audit capabilities, prioritizing:

• Wealthy taxpayers: Audit rates for individuals earning over $1 million rose significantly in recent years.
• Foreign asset reporting: Enhanced scrutiny of FATCA and FBAR compliance.

Insight: According to MarketWatch, the IRS is now leveraging advanced data analytics to identify discrepancies more effectively, making thorough and accurate reporting more crucial than ever.

Comparative table of audit timeframes

To help you understand the scope of IRS audits, here’s a quick breakdown of the timeframes based on various scenarios:

Key takeaway: The audit period extends significantly if there’s substantial underreporting, non-filing, or fraud.

What are my rights when the IRS concludes an audit?

There are two ways the IRS can conclude your audit.

1. Proposed “No changes”

Proposed “no changes” as a result of the IRS examination. This means that everything reported is backed up with evidence and they found no irregularity.

2. Proposed changes

Proposed changes as a result of the IRS examination. This will result in one of the following two scenarios.

• Agree. If you agree with the proposed changes you will be presented with an examination report or form to sign. Use the available payment option if you owe additional taxes to the IRS.
• Disagree. If you disagree with the proposed changes you can either:
  
  
  • Seek help from Alternative dispute resolution to mediate between you and the IRS;
  • File an appeal provided that the statute of limitation is still intact.

As a taxpayer, you have the following rights:

a) Be informed

This means you have the right to:

• Know the reason you are required to provide information to the IRS while filing a tax return or being audited;
• Be informed about the IRS decisions and the outcome of your tax audit;
• To get clear explanations of all the tax laws, regulations, and procedures.

b) Challenge the IRS’s position

If you disagree with the audit conclusion you have the right to challenge it. You can seek assistance from IRS mediation services and expect to be heard.

If the matter remains unresolved you have the right to appeal on an independent forum for a fair hearing. If the conflict still persists you can go to court.

NOTE! Before you take the matter to court it would be wise to discuss the possible outcome with a tax & legal expert.

c) Privacy and confidentiality

Any enforcement actions and inquiries from the IRS will not be more intrusive than necessary and any information you provide them will not be disclosed unless you authorize them or it is required by law.

d) Representation

You can authorize enrolled agents, CPAs, or attorneys to represent you in audit and payment collection issues. These tax professionals have unlimited representation rights because of their qualifications and credentials as tax preparers.