Every taxpayer dreads when they receive an envelope with those three bold letters on it; IRS. The situation gets worse when you find out that you’ve been selected for “examination” as the service likes to term it (i.e. audit). Have you ever wondered why some tax returns are selected for further review while most are ignored? For example, in 2013 (FY 2014 is the most recently available data) there were 145.2 million individual tax returns filed, of which 1.2 million were selected for review in 2014. Thus the effective audit rate was 0.86%. So the odds are pretty low that your return will be picked for review. However, those odds may change depending on if IRS computers detect any of the following “red flags” when your return passes their always watchful eyes.
Failing to Report All Taxable Income
All those 1099s and W-2s you receive; well the IRS gets copies of them as well. The IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch (e.g. too little or too much being reported) sends up a red flag. If it’s a computational error, the IRS will usually fix it and send you a letter with the changes and additional tax owed. If it’s a reporting error (meaning it was reported under your SSN but it didn’t belong to you), then you will want to contact the IRS/issuer so that it can be corrected.
Running a Small Business
Those who operate their small business as a “sole-proprietor” will report their activity on Schedule C. This form tends to be a treasure trove of tax deductions for sole-proprietors and a gold mine for IRS agents. Why? Well those at the service know that those filing the form sometimes claim excessive deductions or don’t report all of their income. Special scrutiny is typically given to cash-intensive businesses (taxis, car washes, bars, hair salons, barbers, etc.) and those who report substantial losses. Also, the audit rates increase depending on how much they earn. Acco