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The U.S. Internal Revenue Service has decades of experience dealing with tax returns and in that time has developed statistical, formulaic and numerical data on higher risk tax filings in terms of potential tax evasion. The IRS has developed an audit alert warning system that is triggered by certain risk factors that correlate with information submitted and/or not submitted on tax filings. These triggers may be applied to business tax filings. Some of the "red flags" that may cause an IRS audit are as illustrated in the following sections.

SECTION I: BUSINESS TAX FILING RED FLAGS

Unreported Business and/or staff Income:

Businesses such as restaurants and sole proprietorships may erroneously or fraudulently under-report certain forms of income leading to a lower reported taxation to the IRS. Certain types of businesses such as those mentioned above are more likely than others to report incorrect amounts and are thus at greater chance of being audited.

Over reported Expenses:

Another potential trigger for a business audit is over reporting business expenses such as automobile expenses, meal expenses, or inventory space used. Typical businesses of certain sizes generally have a 'normal' range of expenses that can be expected, however tax filings that fall outside of this range or are quantitatively unrealistic may set off an Internal Revenue Service warning algorithm.

Inconsistency with Historical Tax Filings:

Businesses may follow various trends such as accounting methods, income growth, expense deductions, employee withholding, depreciation etc. When these trends become unrealistic the probability increases the tax filing is erroneous. For example, if a business reports depreciation of 2% every year for 5 years in a row and then reports depreciation of 7% this indicates a change in accounting methods from straight line depreciation to accelerated depreciation. Changes like this and other adjustments to accounting systems may have to be formally reported and could lead to an audit.

Missing IRS Forms:

Every business, whether it be a sole proprietorship, partnership, limited liability corporation, S-Corporation or C -Corporation has certain filing requirements which include specific forms to be completed and sent to the IRS. For example, partnerships are required to file a form 1065 or U.S. Return of Partnership Income. If these forms are missing or incomplete there is a significant chance the IRS may inquire further, request more information or audit the business.

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