The IRS performs many audits of various tax returns either on a random basis or on suspicion of tax fraud or errors in reporting. Though there is no sure way of avoiding such an audit, there are several red flags that can increase the chances of being subjected to an audit. Some of these red flags are described below:

Unmatched Reports

Your IRS returns are recorded in a self-matching system to ensure that the information received is crosschecked by a corresponding entry from a related return. If you pay for a contractor to upgrade your rental apartments for example, the IRS will expect a corresponding entry in the contractor’s tax returns as an income. If the IRS is unable to match any incomes or any deductions, they will most likely contact you and request for support documents or perform an audit, depending on the magnitude of the discrepancy. Therefore, always crosscheck the figures indicated in your returns with the numbers provided in invoices, receipts, 1099, W-2, and other tax related documentation.

Home Office Related Expenses

Home offices are another common audit red flag for the IRS. Because it is at times, hard to allocate the expenses used for personal use and those used for the business, the IRS tends to question and investigate these cases. In many instances, home office business individuals lump all the expenses to the business, including those for personal use. The IRS may therefore, audit such businesses and seek explanations on how expenses are allocated between business and personal use.

Tip Off Information

Another common red flag for audit is information provided to the IRS by a third party as to a suspected tax cheat. The IRS provides up to 20% of the taxes recovered, including penalties and interests, to any individual who provides information to the IRS regarding tax evasion of any nature. Therefore, it is advisable to avoid discussing your taxes others, especially those not related in any way to your taxes.

Rental Income Losses

Over the past years, rental income has been a major loophole for irregular deductions and tax evasion. For this reason, the IRS has placed various limitations and rules to govern and regulate the taxes relating to rental income. Losses are limited to a deduction of $25,000 and you need to show profitability with rental property. Rental income returns are also a red flag for IRS audits.

Large or Recurrent Business Losses

Having large business losses is another red flag for an audit. The IRS will want to know the reason for the loss before they permit you to deduct the loss from future taxable incomes. The IRS will also audit businesses that have frequent losses or low profits as compared to other businesses in the same industry. The IRS allows for 3 consecutive losses after which you will have to convert your business to a hobby. However, if you keep having losses with low profit years in between, it will definitely attract an audit. You should also be careful with business startups, especially if they will make losses, as they are also commonly subjected to IRS audits.

Large Charity Donations

The IRS also places a red flag on large donations made by individuals or businesses that are not proportionate to the incomes or revenues indicated in the returns. The IRS usually uses various statistical trends to compare such things as incomes and charity donations. Therefore, if your donation overly exceeds the average curve of the income-donation correlation, you will most likely get Uncle Sam auditing you.

Independent Contractor Entries

When receiving labor-related services in your business from a third party, you need to be careful whether to record their fee as employment or as fees for an independent contractor. This is another red flag area. You need to be sure that the hours worked and the type of work done does not fall under employee as per IRS regulations. If you indicate employees as independent contractors and the IRS catches up with you, you may be forced to pay personal taxes and other related penalties.