How the IRS catches tax cheats: 3 ways your tax return may get flagged

Cheating on your taxes is a form of high-stakes gambling. You might catch a break and evade suspicion, but the IRS is incentivized to go after those Americans who don’t pay what they owe — an amount that totals hundreds of billions in unpaid taxes each year.

An estimated $514 billion in individual income taxes went unpaid in 2022, according to the most recent IRS data. Add in unpaid corporate, employment and estate taxes and the tax gap that year was $696 billion. Enforcement actions and late payments reduced that amount by an estimated $90 billion.

Some Americans may be even more tempted to roll the dice now that the IRS has slashed its workforce by 25 percent so far this year, according to the most recent data from the Treasury Inspector General for Tax Administration.

While 84 percent of taxpayers say it’s “not at all acceptable” to cheat on income taxes, 29 percent agree it’s fair to avoid paying some taxes if they no longer trust the government will spend taxpayer dollars wisely, according to 2024 results of an annual taxpayer attitude survey conducted by the IRS.

That’s a pretty blasé attitude about a crime that carries consequences ranging from steep fines to potential prison time.

And, while workforce cuts at the IRS could reduce audit activity, the IRS has other ways to monitor for cheating, says Heather Liston, a certified financial planner and principal of Clarity Financial in San Francisco.

In particular, the IRS uses what’s known as a DIF score (for “discriminant function”) to identify problematic returns, and the ratios are intentionally kept a secret so people can’t game the system. “We don’t know what they are because the IRS doesn’t want us to know what they are,” Liston says.

Some common issues that raise potential “cheating” flags with the IRS include math errors, underreporting income, unusually high business expenses or tax deductions, failing to take required minimum distributions from retirement accounts, and cost basis issues with restricted stock units or real estate transactions, Liston says.

Here are three ways the IRS monitors tax returns for cheating.

1. Your numbers don’t match third-party data

When filing your taxes, you must input your wage information from the W-2 form your employer provided to you, along with income you may have earned from other sources that’s documented on various 1099 forms. Those companies must also supply that information to the IRS.

And the figures should match.

“What the IRS really likes, and strives for, is third-party reporting because there’s very little opportunity for cheating,” says Mark Luscombe, a certified public accountant and principal analyst at Wolters Kluwer Tax & Accounting in Chicago. That’s because it’s easy for the IRS to identify reporting discrepancies that are problematic, he says.

If the income or payment information you input doesn’t match what was sent to the IRS, you will receive a CP2000 notice from the IRS.

Read the CP2000 notice to understand why the IRS believes there’s a discrepancy and what you need to do next, Liston says. Even if your inclination is to shove this notice under a stack of papers and ignore it, it’s important that you take action. Call the phone number provided right away if you need more time to figure out why the problem occurred, she adds.

There may be rare circumstances in which you knowingly provide information to the IRS that’s different than what’s on the tax form — in which case you should document why you’re doing so, Luscombe says.

Otherwise, the problem is often easily solved, though you may need to send more money for unpaid taxes. The longer it takes to resolve the issue, you could incur more interest on unpaid taxes and penalties, Liston says. That’s why it’s best to try to avoid receiving this notice in the first place.

“Anything a computer can catch, it will,” Liston says. “In a way, it’s a little bit silly the IRS makes us go through the exercise of filling out the information because they already know it.”

2. Your self-employed business income or expenses seem off

While the IRS’s exact methods for identifying potential instances of cheating remain a mystery, the agency does scrutinize the information that taxpayers report on Schedule C, Liston says. This form applies to taxpayers who are self-employed, either operating a business as a sole proprietor or working as a freelancer.

If you claim very high business expenses every year — particularly in relation to your income — that could draw the attention of the IRS, Liston cautions.

And while you should claim expenses you’re entitled to, it’s important to be accurate, Luscombe says.

There’s a long-held myth that home office-related expenses can trigger an audit. There’s no evidence that’s true, though these expenses could raise some red flags.

There’s “clearly the potential for abuse” with taxpayers claiming a home office that’s actually a part of the house that’s not exclusively used as a home office, as the IRS dictates it should be, Luscombe says. “I suspect there are a lot of ‘home offices’ where the kids go in and watch movies and the like.”

The IRS won’t appear on your doorstep to confirm your home office is the size you claim or that it’s being used exclusively for that purpose, but that myth could be a good reminder to be cautious.

When possible, Liston says, be sure to have documentation of expenses like meals or transportation costs. But just because these expenses could elicit extra scrutiny by the IRS, Liston notes, “that doesn’t mean you shouldn’t claim them.”

3. Your tax deductions or credits seem fishy

The standard deduction for taxpayers was nearly doubled as part of the Tax Cuts and Jobs Act of 2017, which now means that less than 10 percent of taxpayers claim itemized deductions. (That higher standard deduction, plus a new inflation adjustment for 2025, was made permanent as part of the megabill that was signed into law in July.)

Abuses of itemized deductions, particularly related to the value of charitable donations, was once something the IRS closely monitored to identify potential instances of fraud, Luscombe says. And it still does, albeit among the now-minority of taxpayers who itemize deductions.

There are other tax breaks that many Americans can claim that may also seem fishy to the IRS. The IRS seems “very concerned,” Liston says, with catching people who cheat in some way when claiming the earned income tax credit (EITC) for low- to moderate-income workers and families.

While it’s hard to know exactly what the IRS scrutinizes, it’s important to only claim deductions that legitimately apply to your situation.

Resist the urge to underreport your income

Not all income is reported to the IRS through a third-party source, and it may be particularly tempting to omit this information while filing your taxes. That’s because companies are only required to send you — and the IRS — a 1099 form for payments that exceed certain thresholds. And those thresholds were recently raised for some of the most common 1099 forms.

Even if you made less than the amount required to generate a form, the IRS is looking for taxpayers who don’t report all of their income, no matter whether they do so intentionally or mistakenly.

“That could be an honest mistake, but you still need to get caught up and make it right,” Liston says.

You should receive a 1099 form if you did contract or freelance work that totaled at least $600 for one company in 2025, though the massive new tax bill signed into law in July boosts the reporting threshold for 1099-NEC and 1099-MISC forms to $2,000 starting in 2026.

That same tax law also changed the reporting threshold for 1099-K forms — which report payments of goods and services on platforms like Venmo, Cash App and PayPal — to $20,000 plus 200 transactions. That reporting threshold is now in effect for 2025.

The IRS has been pushing for more third-party reporting, especially in the case of the 1099-K forms, to ensure taxpayers are fairly reporting all of their income, Luscombe says. But the agency has been challenged by companies that argue this paperwork is unduly burdensome, he adds.

The higher reporting thresholds — meaning that you can receive a higher amount of freelance income without the company that paid you reporting it — may tempt you to report less income. But knowingly omitting this income when you file your tax return is fraud. Even if it seems unlikely the IRS will catch you, you don’t get off the hook for reporting income just because you don’t receive a form for it, Liston says.

“I never advise anyone to lie about that,” she says. “You are responsible for reporting all of your income.”

Why double-checking your tax return is so important

Before you file your taxes, go through your return to make sure nothing stands out as peculiar. A vast majority of taxpayers now file their taxes electronically, which has reduced simple math errors, but you could still make a small mistake that will result in a big headache with the IRS.

Receiving a notice in the mail from the IRS about a problem with your return, while unpleasant, doesn’t necessarily suggest you’ll be audited or accused of fraud.

It’s “really important” not to panic, Liston says, though you need to take these notices seriously and reply in a timely manner, and that’s particularly true if you have an explanation for why the information you supplied differs from the IRS’s calculation.

And you won’t be surprised by a notice that immediately accuses you of tax fraud. Rather, that accusation will only come after a series of notices and fair warning before the IRS formally accuses you of tax fraud after a thorough investigation.

Finally, your intent matters. Some taxpayers confuse tax avoidance via legitimate planning and legitimate tax strategies with tax evasion, in which you’re illegally trying to lower your tax obligation. The two terms are very different, Luscombe says. “Fraud implies a willfulness to it.”