The New York Times published an interesting article, yesterday If The I.R.S. Is Watching You, You'll Pay Up, about the psychology behind cheating on one's taxes. While the article does not get into specifics about how the IRS identifies tax cheats, it does provide some interesting pieces of information. Specifically, first, it mentions the fact that small business owners are the people most likely to report income and deductions incorrectly, second, the lack of funding has reduced the IRS's enforcement ability, and finally, the service is regularly trying new ways to encourage compliance. The article also has a few quotes from law professors and the IRS commissioner; it is worth a quick read.
As with everything related to the IRS, it is hard to provide comprehensive information related to taxes on the web. This post is for general information and is not legal or tax advice. Please do not rely on this article without consulting a tax professional.