8 IRS Red Flags on Tax Returns: How to Avoid Audits & Letters -part 2

Red Flag #6: Cash-Heavy Businesses

If you own a business that deals mostly in cash (like a restaurant, salon, or taxi service), the IRS pays extra attention to your tax return. They know it's easier to underreport income when many transactions are in cash.

Why It Triggers IRS Attention

The IRS has special programs that look at typical income patterns for different types of businesses. If your reported income is much lower than what's typical for your business type and size, it raises questions.

How to Avoid This Mistake

• Keep detailed records of ALL cash transactions

• Consider using a point-of-sale system that tracks all sales

• Make regular bank deposits of cash income

• Report all income accurately, even if it was paid in cash

Red Flag #7: Hobby Losses

If you claim business losses year after year for what looks more like a hobby than a business, the IRS will take notice. A legitimate business is expected to make a profit in at least 3 out of 5 years.

Why It Triggers IRS Attention

The IRS doesn't allow you to deduct hobby expenses against other income. They look closely at activities that consistently lose money to determine if they're really businesses or just hobbies.

How to Avoid This Mistake

• Show that you run your activity like a business (business plan, separate accounts)

• Keep good records showing efforts to make a profit

• If you have losses, document why (startup costs, unusual circumstances)

• Be able to explain how you plan to become profitable

Red Flag #8: Math Errors

Simple math mistakes on your tax return can lead to IRS notices and potentially trigger a closer look at your entire return. Even with tax software, errors can happen if you enter information incorrectly.

Why It Triggers IRS Attention

While a simple math error might just get corrected automatically, multiple errors suggest carelessness and might make the IRS wonder what else is wrong with your return.

How to Avoid This Mistake

• Double-check all numbers you enter into tax forms or software

• Review your completed return carefully before submitting

• Consider having someone else look over your return

• Use tax preparation software that checks for math errors

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How to Stay Off the IRS Radar

The best way to avoid IRS problems is to be honest, accurate, and thorough with your tax return. Here are some final tips to help you stay off the IRS radar:

• Report all income, even if you didn't receive a tax form for it

• Keep good records throughout the year, not just at tax time

• Be consistent from year to year in how you report income and deductions

• When in doubt, include explanations or documentation with your return

• Consider using a tax professional if your situation is complicated

Remember, the goal isn't to pay the least amount of tax possible - it's to pay the correct amount of tax. By understanding these common red flags and taking steps to avoid them, you can file your taxes with confidence and reduce your chances of getting unwanted attention from the IRS.

FAQs About IRS Red Flags

What happens if the IRS finds a red flag on my return?

If the IRS spots a red flag, they might send you a letter asking for more information or explanation. In some cases, they might adjust your return and send you a bill for additional taxes. For more serious issues, they might select your return for an audit, which is a more detailed review of your tax information.

How far back can the IRS look at my tax returns?

Generally, the IRS has 3 years from the date you filed your return to audit it. However, this extends to 6 years if they suspect you underreported your income by more than 25%. There's no time limit if they suspect fraud or if you didn't file a return.

What should I do if I get an IRS audit notice?

Don't panic! Read the notice carefully to understand what the IRS is questioning. Gather all relevant documentation. Respond by the deadline given in the notice. Consider getting help from a tax professional, especially for complex issues or if large amounts of money are involved.

Can I reduce my chances of being audited?

Yes! By avoiding the red flags discussed in this article, you can significantly reduce your audit risk. The most important things are to report all income, keep good records, be consistent, and make sure your deductions are reasonable and well-documented.

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