What Taxpayers Should Know

Ever been audited by the IRS before? A certain percentage of the millions of tax returns that are filed each year are flagged and audited. This is usually done at random, but in some cases, the return is already being investigated for special reasons. No one is sure how the IRS goes about flagging returns for random audit (except that the formula is called the Discriminant Function) as it is a highly classified secret. However, there are several types of returns that the IRS tends to focus on.

Returns that Itemize Deductions

If you report income with Form 1040 attached with a Schedule A, you should be more careful. Additional calculations give a higher possibility for fraud or error.

Self-Employed Taxpayers

For those who report on Schedule C or E, the number of expenses that you can claim as deductions, especially if you report net losses that reduce other taxable income such as salaries or investment income, will most probably be the reason you will be targeted.

Small Businesses

People with small business, like florists, hobby storeowners, construction contractors and other local enterprises are targeted by the IRS simply because business owners and partners often don’t understand the rules for correctly reporting their income and expenses. This is particularly true of those who are filing a business return for the first time.

Private Transactions

If you are involved in the sale of notable real estate or hold interests in oil and gas leases or other such investment property, you should also be more careful. Your line of work can often generate enormous income and profits from individual buyers or small companies, and the IRS knows how easy it can be to underreport the profits from these transactions.

“Cash Cow” Businesses

Businesses such as laundry services, restaurants, casinos, gaming establishments and other similar enterprises operate largely on a cash basis. It is difficult to prove revenue that is collected in cash from thousands of separate transactions, which is why a substantial percentage of those types of businesses underreport their income on their tax returns. It’s no surprise that the IRS keeps a close watch on these types of businesses.

The Bottom Line

Remember, returns are generally selected at random. If the IRS does flag your return, it might simply be for obvious reasons. The best way to avoid any problem is to be thorough and make sure you have proper documentation.

LINKS

* IRS.gov page on Publication 566: http://www.irs.gov/publications/p556/index.html
* Wiki page on IRS tax forms: http://en.wikipedia.org/wiki/IRS_tax_forms