What Are My Chances of Being Audited and How Can I Reduce Them?

Audits are relatively rare, as fewer than 1% of taxpayers grouped by income level will get that dreaded notice on their IRS letterhead.

Statistics show that for the average American who earned $50‒70K per year, only about half a percent of those tax returns were audited. If you made between $25‒50K or between $75‒100K, less than half a percent of those returns were under audit. Only 6.66% of tax returns reporting an eight-figure adjusted gross income were audited as well. Additionally, the IRS has less funding and about one-third fewer agents on board compared to less than a decade ago, so this keeps audit figures down.

In short, your chances are being audited by the IRS are quite slim. There are often many red flags that are likely to trigger an audit, but even then, you’re still more likely to get an examination notice than an actual field audit in which an IRS agent shows up at your door demanding to examine your workspace and files.

An IRS Letter Is Not Likely to Be an Audit

You might think that you’ve been selected for an audit because a letter from the IRS came in the mail that asked you to explain why a line item on your tax return was reported a certain way or that they computed your tax bill for you. A notice is not the same thing as an audit.

Most IRS notices are computer-generated with a “CP” prefix. Notices in the CP series will be automatically mailed to you when changes are made to your IRS account, such as making a payment or having all or part of your tax refund seized to pay down your current balance. These notices are sent with the intent to catch discrepancies and underreporting based on information they already have on file. Examples include if you forgot to report that 1099 you received for additional income, or if there was an error on your W-2.

Requests for more information are often referred to as a “desk audit,” but your contact with the IRS is still largely minimal, particularly if your notice pertains to math or input errors.

Common Audit Red Flags

Despite having a pretty low chance of ever being audited, it’s helpful to know which criteria are the most likely to trigger an audit:

  • Earning $200,000 or more per year. Don’t pass up that promotion or acting on your entrepreneurial instincts, but your chances of being audited increase once you enter the upper middle class. The higher your income, the higher the likelihood of being audited.
  • Home office deduction.  In general, self-employed professionals are far more likely to be audited than employees. But your chances increase when you take the home office deduction, even though it is a perfectly legitimate write-off. It’s not just the amount deducted, but home office deductions are subject to a “regular and exclusive use” rule that many work-at-home types inadvertently violate without realizing it.
  • Suspiciously high charitable contributions. Any larger-than-average deduction is going to arouse suspicion, but charitable contributions are a common red flag. Many people donate to causes they care about, but cash donations are easy to substantiate, as are marketable securities. Did some spring cleaning and gave a lot to Goodwill? People often overvalue non-cash donations and don’t have the time and wherewithal to take pictures and document them unless it’s an extremely valuable item, like donating rare art to a museum that had a professional appraisal.
  • Cash-intensive businesses. Consistent with the high audit rates among the self-employed, any cash-intensive type of work is an audit minefield. While rideshare drivers get a 1099 and can properly track mileage with many apps and tools, discrepancies are still common. Cash-heavy businesses like cafes, laundromats and selling items at craft fairs also provide opportunities to overstate expenses and understate income with little or no substantiation of these numbers.

You should still take advantage of all the tax benefits legally available to you and keep fastidious records you and your tax professional can easily access. This way, you can substantiate any claims if your tax filing status is more complicated than just getting a W-2 from a job. If you are ever facing an audit, either as an individual taxpayer or a small business owner, please contact us.

Why Am I Being Audited by the IRS?

With the 2017 filing season currently behind us, notices have started to appear in mailboxes. While the IRS letterhead strikes fear into the hearts of most Americans, a vast majority of those notices are nothing to fear, since most of them are computer-generated and referring to outstanding tax bills you haven’t paid yet or errors on your tax return that can be easily addressed. Simply getting an IRS notice is not indicative of an audit.

With the numbers in for 2016 tax returns per the release of the IRS’s 2017 data book, fewer than 1 percent of individual tax returns were selected for a field or correspondence audit, which gives most people a 1-in-160 chance. But the Taxpayer Advocate Service watchdog group says that it’s actually 6.2 percent of tax returns, or a 1-in-16 chance of being audited. While audits demand back-up material and examining your past tax returns opposed to simply fixing errors or paying your unpaid tax bills, some of those computer-generated notices are more pernicious in their documentation requests and count in that 6.2 percent. “Audit flags” that don’t merit a full tax return audit but a partial one also count.

An incredibly minute amount of the hundreds of millions of individual tax returns that get filed every year will be audited. But if you want to know why you’re under audit or what the risk factors are that increase the likelihood of being audited, here’s what you need to know about the IRS audit process.

1. You were incredibly unlucky and got randomly selected.
In 2017, only 934,000 tax returns were audited, with 71 percent of them being done by mail, opposed to field audits (those intimidating series of face-to-face meetings you see in movies). Of this number, a microscopic portion were randomly selected.
The IRS always audits an incredibly tiny sample of tax returns, but the likelihood is still extremely low given that the incidence of random selection was reduced under the sequestration in 2013 and remained low even after the IRS petitioned for more funding. But if you are low or middle income with a relatively simple tax filing situation and wondering why you’ve been audited, you were part of that tiny random selection.

2. Your tax return has a common audit flag.
Even if you have legitimate deductions, credits and income substantiation, there are certain lines on your tax return that are rife with errors and fraud across the board. These include the charitable contribution deduction, home office deduction and adoption tax credit.
Specific tax benefits prone to error and fraud like the Earned Income Tax Credit have their own separate due diligence process. But the above three items are the most common triggers for an audit, even just partial audits, given the vast propensity people have in underestimating these items and not having them properly documented. People tend to overestimate the value of non-cash charitable contributions and frequently lack the substantiation for these deductions. Adoption is an incredibly long and expensive process, and even though it is a legitimate tax benefit in which the adoptive parents will have substantiation, it also equates to a tax credit that can spread out over numerous years and result in paying little or no tax. Because of this, the IRS flags these tax returns frequently.
The home office deduction is another area where people tend to overestimate both eligible expenses and the percentage or square footage of the home being used for the deduction. This deduction can also generate a business loss, resulting in paying little or no taxes. Because of this, the IRS is likely to flag tax returns that have suspiciously large home office deductions.

3. Someone tipped off the IRS that you could be cheating on your taxes.
The IRS has a whistleblower program that awards up to 30 percent of the taxes collected and resultant penalties. If your ex-spouse suspects that you fudged your Goodwill donations or that co-worker who doesn’t like you overheard you say, “They never check!” with respect to that side hustle you didn’t report, it’s possible they could’ve anonymously tipped you off to get a quick payday.

4. If you’re a small business owner or freelancer and someone with whom you do business was audited, you have an increased likelihood of being audited.
Even if your client, supplier or other business associate was not committing tax fraud or malfeasance but simply got audited, people and companies that they paid or received money from are likely to be next. If they didn’t correctly report payments made, the IRS will want to see how the payers’ or recipients’ tax returns also match up.

While random selection has a low probability, most audit flags are beyond your control. Always have proper substantiation in case you get that information request.

Our tax relief experts are available to assist you and take the stress out of resolving your IRS notice in the shortest amount of time possible. Please contact us with any questions and if we can be of assistance.