It is important to remember that
the IRS computer systems select
the returns that are to be audited.
No human ever reviews the returns
until they are selected for an audit
by the computer system that determines
returns likely to yield the most
money to the government. It makes
this decision by reviewing returns
for "red flag" characteristics.
Red flag characteristics are those
income, deduction, and credit types
that have historically seen the
most imprecise calculations and
abuse by taxpayers.
Although there are many tax laws
allowing self-employed individuals
to lower their liabilities by using
home office deductions, taxpayers
taking home office deductions are
probably the most frequently contested
by IRS because they are easy for
a taxpayer to bend the truth on.
In order to claim a home office
deduction, a taxpayer's home office
must be the principal place of business
This means they perform most of
their work in the home office. Also,
the space must be used exclusively
for running the business and not
for personal use as well. Otherwise
the space cannot be considered a
home office and may not be deducted.
The IRS offers hundreds of possible
deductions and credits to help taxpayers
lower their income tax liability,
but taking an excessively large
amount will send a very clear red
flag to the IRS. But how does a
taxpayer know what's excessive?
That is a tricky question to answer
as there is no all-applying rule
because the IRS determines the allowable
number of deductions for a taxpayer
mostly based on their income.
Losses from a business can also
be another red flag for the IRS.
If an individual starts their own
businesses for the purpose of generating
excessive tax deductions, the IRS
will catch on quickly. Businesses
must be profitable in at least three
of the past five years in order
to be considered a legitimate business
for tax purposes. Otherwise the
IRS will realize the business is
functioning as a tax shelter.
If there are differences in the
income you reported to your state
treasury and to the IRS, then the
IRS will investigate as to why the
information reported is inconsistent.
Not only do federal and state authorities
receive records of all sources of
income and financial information
for every taxpayer - the IRS does
as well. If they notice any errors
that point to misrepresentation
of income then you can expect to
receive a letter informing you of
an audit.
If there are big inconsistencies
between your previous tax returns
and your current return then you
could be sending a red flag to the
IRS. The most common examples are
name changes (i.e. your name or
the name of one of your dependents),
claiming new deductions and credits,
or a significant change in income.
For example, if a taxpayer earned
$75,000 one year, then only $15,000
the next, the IRS is going to wonder
what happened.
If your tax returns are incomplete
or sloppily prepared then this might
also get the attention of the IRS.
If there are blanks where there
should be numbers or if most of
the numbers you claim are round
numbers (like $2,500 or $10,000)
then this will also send up a red
flag to the IRS.
