6 Common Red Flags the Lead to Tax Audits

The IRS audits nearly 1.5 million tax returns every year. But how do they decide which returns should be audited (or "examined" in IRS terminology)?

While there are many factors that can trigger an audit, here are some of the most common factors that can result in an individual or a business receiving notice of an examination from the IRS.

3 Red Flags On Business Returns

Being self-employed: Those who are self-employed face a higher than average chance of an audit. This is due to the IRS putting special attention on making sure that business and personal deductions are not mixed up or used improperly.

Cash businesses: If you operate a cash-based or cash-intensive business, you'll face additional scrutiny from the IRS. The agency will often want extremely extensive documentation of how much cash came into the business and how that cash was spent.

Choice of business entity: The IRS has noticed a trend - audits of LLCs, S-Corps and other business entities favored by small businesses tend to have a good return on investment and effort. As such, those who utilize these types of business entities should prepare for the possibility of a visit from an IRS officer or a letter from the IRS.

3 Red Flags On Individual Returns

Not reporting all income: If your return does not match the information the IRS has received, such as if you don't report some income but the IRS received a W-2, 1099 or other form from the business that paid you, it's very likely that you'll be hearing from an IRS agent.

Taking the home office deduction: The home office deduction is one of the most misunderstood, and most incorrectly used, deductions available. If you claim it, the space you are claiming it for must be used exclusively for your business and it cannot be used even on rare occasions for personal use. Most spaces cannot meet this requirement; knowing this, the IRS targets returns that claim this deduction.

High income: Those making more than $200,000 have a significantly higher chance of being audited than anyone who has income below that amount. Once you cross the $1 million threshold, you have an almost 1-in-10 chance of being audited.