Red Flags
There’s no surefire way to avoid
being audited, but there are red flags
to watch for. Here are five big ones.
By Inc. Staff
1. Simple mistakes At a time when the vast
majority of the IRS’s audits are correspondence
audits—the tax agency sends you a letter telling
you that you owe more—a careless mistake can
flag your return for closer inspection. Doublecheck
that you’ve included your Social Security
number or taxpayer identification number, that
you’ve not made any dumb math mistakes, and
that you’ve signed and dated the document.
2. Being out of line with the averages The IRS uses
a complex mathematical formula to score tax
returns for audit-worthiness. The details of precisely
what goes into the formula score are top
secret, but it is believed to identify tax returns
that are out of line with the averages from a
cross section of returns, as well as those that are
out of line with a taxpayer’s past history.
3. Tax shelters Cracking down on illegal tax shelters
is one of the IRS’s top priorities. Under
recent regulations, you’re required to disclose
any aggressive moves that could be considered
shelters, and the penalties for nondisclosure are
significant. If you do disclose a questionable
transaction, you’ll probably be audited. But if
you don’t and the IRS finds you’ve engaged in
an abusive tax shelter, the fines and penalties
could put you out of business.
4. Big deductions For entrepreneurs, a big issue
is just where business ends and personal life
begins. Big travel and entertainment deductions
can raise a red flag, as can write-offs of corporate
cars and planes. The rule is that to deduct
it at all you must use it at least 50 percent for
business; if you don’t use it exclusively for business
you have to keep tabs on your work and
personal travels to come up with the proportional
tax benefit.
5. Family members on payroll Count on the IRS
to look closely at business dealings with family
members and other related parties. If family
members are on the payroll, do they really work
for the company? Is rent paid to entities owned
by the business founder? If so, is that rent near
the current market rates?
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