How the IRS Flags a Return

• As soon as the IRS receives a tax return, it feeds it into a computer. The computer checks it to see if it falls within reasonable parameters and if the numbers add up. The computer then produces a score. If a score is too high, this prompts a flag. The IRS also uses teams of agents to pull out certain returns for closer inspection, even if they pass the computer test. According to "Wall Street Journal" MarketWatch, these teams usually look at cash businesses rather than individuals, because such businesses have a high record of not reporting all the income they take in.
  
  

Simple Mistakes

• If a computer generates a flag, it's possible that the return only has a simple mathematical error. According to both Kiplinger and MSN Money, this is the primary reason the IRS may flag a return. A computer will notice the discrepancy and alert an agent. However, this generally results in a letter telling the taxpayer that something is wrong and that he needs to address it, not a full-fledged audit. The IRS also pays "whistleblowers" well, up to 30 percent of any extra taxes that result from an audit. A tip from a disgruntled employee could earn a flag for a return.
  
  

Outstanding Child Support

• Even if a tax return is perfectly in order, the return might result in a flag if the taxpayer owes any outstanding child support. This is different from an audit flag. Procedures vary from state to state, but most child-support collection units will send information to the IRS if a person who owes child support falls too far behind. This IRS feeds this information into its computer system and when the tax return arrives for processing, the computer flags it so the IRS can deduct child support arrears from the refund and send the money to the state's collection unit.
  
  

Unusual Deductions

• If the taxpayer doesn't run a cash business, hasn't made mathematical errors, and doesn't owe past-due child support, the flag might stem from the fact that the deductions are more than income can reasonably support. This isn't to say that the deductions are not all legitimate, only that they will call attention to the return and cause the computer to flag it. The most common deductions that draw the attention of the IRS are for home offices and for "hobby" expenses, such as if a taxpayer is not self-employed in the gem industry but still claims loss from diamond mining as they pursue this in their spare time in the hopes of making extra money. Other deductions that the IRS might flag include excessive entertainment deductions and large charitable contributions that don't make sense in comparison to income. Any taxpayer that commonly uses these types of deductions should keep receipts for at least three years. By statute, the IRS has that long to react to a flag and audit a return.