The IRS Is More Likely To Consider You For An Audit If You Deal In This Transaction Type

Tax administration is still a big task for the federal government every year. The Internal Revenue Service (IRS) processed more than 266 million tax returns in fiscal year 2024. It collected $5.1 trillion in gross receipts. Out of those, 82.5% — that's over 219.9 million — came in electronically. This shows the agency's ongoing effort to go digital. But it also aims to make reporting clearer. However, the Internal Revenue Service Tax Gap Report pointed out a big issue. A large chunk of the tax compliance gap sits at $496 billion for tax years 2014 through 2016. Much of that links to transactions that are tough to track or check.

Cash transactions consistently stand out as a primary concern for agency audit teams. The IRS is far more likely to audit returns with significant cash activity, since it raises red flags. Many taxpayers inadvertently create audit red flags on their taxes by not properly documenting cash-heavy activities or mixing personal and business expenses. Those slip-ups make audits more likely. Cash draws extra scrutiny because it so often connects with misreporting, lack of clarity, or repeated compliance issues.

If your business deals mostly in cash — restaurants, corner stores, salons, repair shops — you're more likely to catch the IRS's attention. Agents often check whether the income you report lines up with deposits and expenses from your tax returns. Any mismatch can raise an immediate red flag. This is especially true for companies with business expenses that appear excessive compared to reported revenue.

One way the IRS identifies potential audit targets is through "industry comparison." It runs models to see how a business stacks up against others of similar size, type, and location. For example, a small repair shop shows unusually low income but unusually high deductions compared to peers. That gap alone can prompt the IRS analytics teams to dig deeper. It pushes businesses to keep clean, accurate books – receipts, logs, and records for every dollar.

Cash reporting rules are strict, making compliance key. The Internal Revenue Code requires reporting any cash transaction over $10,000 to the IRS within 15 days using Form 8300. The IRS will flag your taxes for audit if you fail to file this form. Plus, not holding onto records for at least five years could lead to fines starting at $25,000 per violation. That is enough to completely erase profits for most small operations. Still, these steps aim to curb financial fraud and tax evasion. Ramping up pressure for cash-heavy businesses.

In 2025, the IRS tightened its grip on unreported tip income and side gig cash. Tips, off-the-books cash, and even digital assets like cryptocurrency are all flagged as audit triggers. Any gap between what you report and what shows up from payment networks or employer filings can trigger an investigation. This may result in a simple automated notice or, in some cases, a full audit — even if the difference is only a few hundred dollars.

With new tech and AI, the IRS spots red flags faster than before. It now cross-checks tax filings with third-party reports, bank records, even real estate and vehicle registrations. That makes it harder to hide mismatched income and spending. This sophisticated tracking can even detect when taxpayers make foreign bank account mistakes. Lifestyle audits, on the other hand, are triggered when the IRS sees spending patterns that don't match reported income. If someone declares a modest income but drives luxury cars or takes lavish trips, the IRS may step in to see if the spending lines up with what's on the return.

Digital payments have also closed reporting gaps. According to the Internal Revenue Service, you'll get a Form 1099-K if payments for goods or services add up to more than $5,000 in 2024, $2,500 in 2025, and $600 in 2026 through apps like Venmo, PayPal, or Cash App. Transfers from friends and family are excluded, since gifts aren't reported with that form.