It is without a doubt the most dreaded letter that anyone can receive as a taxpayer; the letter that says you’re being audited by the Internal Revenue Service.
If you’ve gotten one, you’ve joined an infamous club where the initiation is an audit by the IRS and, unfortunately, you can’t refuse membership. Also, the dues you pay could possibly be astronomical.
The good news for millions of taxpayer’s is that, back in 1998, the IRS Restructuring and Reform Act ordered the IRS to focus more on taxpayer rights and less on collection activities. Not surprisingly, the number of audits (or what the IRS refers to as “examinations”) dropped quickly and dramatically.
During that first year about one out of every 79 tax returns were audited but, by 2003, that number fell to one in 150 (which was a lot better for tax scofflaws). Today the number of audits remains, thankfully, quite low and, in fiscal year 2013, less than 1% of returns that were filed were audited, the fewest amount in the last five years. That equals about 1.4 million people.
In the last few years however, pressure from a stressed out Congress that’s dealing with a growing federal deficit has brought more pressure back to taxpayers as the IRS has made it clear that enforcing their policies is becoming job one again. Luckily, the average American isn’t normally targeted by the IRS, which focuses on wealthy consumers.
For example, your chance of being audited in 2013 was .88% if you made less than $200,000. That actually fell from 2012 and .94%. If you made between $200,000 and $1 million last year, you had a 3.26% chance of being audited which, frankly, still wasn’t so bad.
If you made more than $1 million last year however the chance of getting audited skyrocketed to nearly 11%. The good news is that, even though that’s a high number, all of the audit rates for 2013 were actually down from 2012. One of the reasons for this was that general budget cuts actually forced the IRS to pull back on much of its audit operations, and furloughs during last summer’s sequestration didn’t help either.
As far as lowering your risk for being audited, one of the best tips comes from Robert Nath, the author of The Official Guide to Dealing with the IRS. He advises that it’s best to be “just one of the crowd”. “Don’t draw any more attention to your return then you need to,” he says, adding that “simple, plain vanilla returns are fairly safe.”
Truth be told, the scoring formula that the IRS uses to determine which tax returns will be audited is a closely guarded secret. Nath however, being a tax attorney in the Washington, DC metro area, says that the fact that the IRS system is designed to screen higher income returns that could put more money in the government’s coffers is no surprise.
He gave a list of a number of things that cause red flags, including;
- Higher levels of income (duh)
- Income different from basic wages including things like contract payments
- Any type of unreported income like investment returns
- People who have home-based businesses and lots of home office deductions
- Charitable deductions that were not made in cash
- Large deductions made for business meals and entertainment
- A high amount of business auto usage
- Any type of losses that were not from a business but rather from something more akin to a hobby
- Casualty losses that were overly large
One last thing that Nath warned about is that the new tax break for lower income wage earners, the “earned income tax credit”, is also something that happens to be catching the eyes of the IRS. The reason is that, due to its complexity, many people make mistakes on their returns. Of course some have been filing false claims as well, and the IRS is on to these claims.