Ten IRS Audit Red Flags for Retirees in 2025

WDC NEWS 6 STAFF February 16, 2025

10 8 minutes read

Ten IRS Audit Red Flags for Retirees in 2025

As you bask in your retirement years, traveling, enjoying dinners with your friends, spending time with family, finding new hobbies, and returning to old ones, you may think your chances of an IRS audit would be low. After all, why would the IRS examine tax returns that you file in your golden years? And generally, you would be right.

Over the past few years, the IRS has been auditing significantly less than 1% of all tax returns filed by individuals. The audit rate is likely less for retirees, who don’t claim as many refundable credits as other taxpayers and whose returns are generally not very complicated. However, not all retirees are in the clear in terms of IRS audits.

The Inflation Reduction Act gave the IRS $80 billion in extra funds over 10 years, with a large chunk of that money to be used by the agency for enforcement activities. Congress has since clawed back a sizeable chunk of the funding, and Republican lawmakers are itching to entirely repeal the IRS’s windfall.

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A retiree’s chances of being audited, or otherwise hearing from the IRS, can escalate depending on various factors, including the complexity of your return, the types and amounts of deduction or other tax breaks you claim, and whether you happen to still be engaged in a business.

Other actions or activities can boost the odds of an audit, too. In the end, there’s no way to predict whether you will be audited in your retirement years. But, these ten audit red flags could increase the chances that the IRS will give your return unwelcome attention.

1. Failing to report all taxable income

Failing to report taxable income from wages, dividends, pensions, IRA distributions, Social Security benefits, and other sources will almost certainly draw unwanted attention for retirees from the IRS.

The IRS gets copies of all the 1099s and W-2s you receive. This includes the 1099-R (reporting payouts from retirement plans, such as pensions, 401(k)s and IRAs), SSA-1099 (reporting Social Security benefits), and 1099-K (reporting online payment sources such as PayPal, Airbnb, Etsy, etc.).
This year, a 1099-K is required to be sent to individuals who, in 2024, received $5,000 or more in payments from these third-party settlement networks for providing goods and/or services.
So, if this applies to you, be sure you received the 1099-K form before you file your return. The threshold for 2025 1099-Ks mailed out in 2026 is $2,500.

The IRS’s computers cross-check the numbers on the 1099 and W-2 forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a notice that the IRS will send to you.

So, be sure to report all income, whether you receive a form such as a 1099 or not.

2. Making a lot of money

While the overall individual audit rates are extremely low, the odds increase significantly as your income goes up, as it might if you sell a valuable piece of property or get a big payout from a retirement plan.

The U.S. Treasury Department and the IRS say that the extra enforcement funds they are receiving courtesy of the Inflation Reduction Act will be used in part to audit more high-net-worth individuals and pass-through entities, such as LLCs, S corporations, and limited partnerships, among other taxpayers.

Treasury officials have made a big promise, saying that taxpayers earning under $400,000 won’t see increased audit rates relative to recent years. However, only time will tell if the IRS can keep this promise.

Also, the IRS has been criticized for ignoring wealthy taxpayers and instead putting too much scrutiny on lower-income individuals who take refundable tax credits. Partly in response to this criticism, but also to close the tax gap, the IRS is increasing its focus on wealthy individuals.

So, it’s not that you shouldn’t try to make less money in your retirement – everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you will be hearing from the IRS

3. Claiming large deductions or losses

If the deductions or losses on your return are disproportionately large compared with your income, the IRS may pull your return for review.

A large medical expense could send up a red flag, for example.
Taking a big loss from the sale of rental property or other investments can also spike the IRS’s curiosity, especially if the loss offsets income from wages, pensions, or other sources.
Also on the IRS’s radar are deductions taken for bad debt and worthless securities, especially if you report the amount as an ordinary loss.

But if you have the proper documentation for your deduction, loss, or credit, don’t be afraid to claim it. There’s no reason to ever pay the IRS more tax than you owe.

4. Gambling winnings and losses

Retirees generally have more time to spend on entertainment activities. Maybe you enjoy going to the casinos and gambling. Or perhaps you started betting more on sporting events now that sports betting is legal in most states. Whether you’re playing the slots, gambling on sporting events, trying your luck at a lottery jackpot, or betting on the horses, one sure thing you can count on is that Uncle Sam wants his cut.

Recreational gamblers must report gambling winnings as other income on the 1040 form. Professional gamblers show their winnings on Schedule C. Failure to report gambling winnings can draw IRS attention, especially because the casino or other venue likely reported the amounts on Form W-2G.

Claiming large gambling losses can also be risky. You can deduct these only to the extent that you report gambling winnings. Writing off gambling losses, but not reporting gambling income, is sure to invite scrutiny. Also, taxpayers who report large losses from their gambling-related activity on Schedule C get an extra look from IRS examiners, who want to make sure that these individuals really are gaming for a living.

5. Not taking required minimum distributions

The IRS wants to be sure that owners of IRAs and participants in 401(k)s and other workplace retirement plans are properly taking and reporting their required minimum distributions (RMDs). The agency knows some people aged 73 and older (75 and older beginning in 2033, 72 and older for 2020-22, and 70½ and older for years before 2020) haven’t taken their annual RMDs. Those who fail to take the proper amount can be hit with a penalty of as much as 25% of the shortfall.

It is also important to know that there have been changes to the rules for many non-spousal beneficiaries of IRAs inherited after 2019. If you’re unsure about when you are required to take RMDs, consult a professional.

6. Taking an early distribution from an IRA or 401(k)

The IRS wants to be sure that owners of traditional IRAs and participants in 401(k)s and other workplace retirement plans are properly reporting and paying tax on distributions. Special attention is being given to payouts before age 59½, which, unless an exception applies, are subject to a 10% penalty on top of the regular income tax.

The IRS knows that a substantial number of filers make errors on their income tax returns concerning retirement payouts, with most of the mistakes coming from taxpayers who don’t qualify for an exception to the 10% additional tax on early distributions.

The IRS has a chart listing withdrawals taken before the age of 59½ that escape the 10% penalty. Some of the exceptions apply only to IRAs, some apply only to workplace retirement plans, and others apply to both.

7. Claiming large charitable deductions

We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. And retirees especially like to make donations to their alma mater, place of worship, a non-profit arts organization, an animal protection shelter, or to any other charities that are near or dear to their hearts. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag.

That’s because the IRS knows what the average charitable donation is for people at your income level. Also, if you don’t get a written appraisal for donations of property valued at more than $5,000, or if you fail to file Form 8283 for noncash donations over $500, you become an even bigger audit target. And if you’ve donated a conservation or facade easement to charity, or if you are an investor in a partnership, LLC or trust that made such a donation, your chances of hearing from the IRS rise exponentially.

Be sure to keep all your supporting documents, including receipts for cash and property contributions made during the year.

8. Running a business

Schedule C is a treasure trove of tax deductions for self-employed individuals. But it’s also a gold mine for IRS agents, who know from experience that self-employed people sometimes claim excessive deductions and don’t report all their income.

The IRS looks at both higher-grossing sole proprietorships and smaller ones. Sole proprietors reporting at least $100,000 of gross receipts on Schedule C, cash-intensive businesses, and business owners who report a substantial loss and have income from other sources such as wages or retirement income, have a higher audit risk.

If you’re semi-retired but still running your own business, or if you have a side business in your golden years, be sure to accurately report all your income and keep good records and receipts to document expenses you claim on your return. Sloppy recordkeeping makes it easy for a revenue agent to disallow your deduction.

9. Deducting hobby losses on Schedule C

Your chances of “winning” the audit lottery increase if you file a Schedule C with large losses from an activity that might be a hobby, such as dog breeding, jewelry making, horse racing, or coin and stamp collecting. Your audit risk grows further if you have multiple years of hobby losses and lots of income from other sources. So be careful if your retirement pursuits include trying to convert a hobby into a moneymaking venture.

To be eligible to deduct a loss, you must be running the activity in a business-like manner and have a reasonable expectation of making a profit.
If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes that you’re in business to make a profit, unless the IRS establishes otherwise.
The analysis is trickier if you can’t meet these safe harbors. That’s because the determination of whether an activity is properly categorized as a hobby or a business is then based on each taxpayer’s facts and circumstances.

10. Claiming large rental losses

Do you own some rental properties that help to provide a consistent revenue stream in your retirement years? Maybe you regularly claim large depreciation deductions and other write-offs on Schedule E that end up generating a tax loss from your rental activity. Claiming a large rental loss can command the IRS’s attention, especially if the loss helps to offset income from other sources that you report on your return.

Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. This $25,000 allowance phases out as modified adjusted gross income exceeds $100,000 and disappears entirely once your modified AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and more than 750 hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off rental losses.

The IRS actively scrutinizes large rental real estate losses. If you’re managing properties in your retirement, you may qualify under the second exception. Or, if you sell a rental property that produced suspended passive losses, the sale opens the door for you to deduct the losses. Just be ready to explain things if a big rental loss prompts questions from the IRS.

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