It’s a secret as closely guarded as the recipe for Coca-Cola: the algorithms built into the Internal Revenue Service’s computers that help determine which US taxpayers get audited. And yet, you can make some educated guesses based on reports of who has been audited in the past.
While some individuals get tapped for an audit by chance—some selections are random—others have tax returns with similar characteristics. There’s no handbook telling you what you can do to avoid getting that dreaded letter from the IRS. There are, however, steps you can take when preparing your return that might reduce your likelihood of being audited.
What Are Your Chances of Getting Audited?
What are your chances of getting audited? Quite slim. “Less than 1%” is the answer most tax experts give. The Transactional Records Access Clearinghouse (TRAC), a nonpartisan, independent data gathering, and data research and data distribution organization at Syracuse University, gets even more specific. It reports that last year the chance of being audited was 3.8 out of every 1,000(Opens in a new window), or 0.38%.
Not surprisingly, the same report from TRAC showed that individuals earning $1 million or more per year were the group most likely to be audited (2.38%). But the second most likely group included those taxpayers who made the least money: less than $25,000, and claiming the Earned Income Tax Credit. They were audited at a rate of 1.27%. This is despite the number of returns filed by the lowest-income segment of the population being so much larger than that of the wealthy class (23,526,35 compared with 703,576).
If three years have passed since you filed a return, you’re unlikely to be audited. But the IRS can go back as far as six years if it notices a substantial error.
How Does the IRS Select Individuals for Audits?
The IRS uses several methods to select returns for audits, says Brittany Benson, senior tax research analyst for H&R Block, including random selection and screening via computer. “This means the IRS automatically applies a statistical formula to select returns and compare them to other, similar returns,” she says. These “norms” are developed through random audits as part of the IRS National Research Program.(Opens in a new window)
Another method used to select which returns are audited is through what’s called “related examinations.” The IRS may select a return if it involves issues or transactions with other taxpayers whose returns were selected for audit, like investors or business partners.
You can also get audited if you don’t report income data found in one or more of your 1099s, says Marc Dupe, head of tax at Nelopy Accounting, a full-service accounting and tax firm in Atlanta. The IRS gets copies of your 1099s, too, and the agency checks to make sure that what it knows about your income shows up on your return.
Other triggers Dupe mentions include:
Filing the wrong tax return for your business entity.
Claiming a business loss for more than three years in a row.
Using only whole numbers.
Reporting an unusually large number of deductions for your income.
Filing for a cash-heavy business, like a restaurant or bar.
Other scenarios that may put you at greater risk for an audit include claiming the home office deduction and having foreign income and assets.
The IRS notes that filing an amended return does not affect the selection process of the original return. However, amended returns also go through a screening process and the amended return may be selected for audit.
Racial Disparities in Audits
Sheletta Brundidge, a Black small businesswoman in the Minneapolis-St. Paul area, was audited last year. When she started talking to her other Black entrepreneur friends, she learned that many of them had been audited, too.
“Everyone was getting audited and I couldn’t figure out why,” she says. She referenced a recent study(Opens in a new window) conducted by Stanford University’s Institute for Economic Policy Research in conjunction with the US Department of the Treasury that found “Black taxpayers receive IRS audit notices at least 2.9 times (and perhaps as much as 4.7 times) more often than non-Black taxpayers.”
The authors of the report do not believe that this is intentional. Rather, they say that the disparity is driven by a set of internal IRS algorithms. Like the recipe for Coca-Cola, they’re a secret.
Brundidge went into her audit with her accountant, who answered all the questions and did all the work, presenting a spreadsheet that contained all of Brundidge’s business expenses. Since she keeps every paper receipt in file boxes organized by the month, it was easy during the audit to go back into each month and find individual receipts from Office Depot or the post office, for example.
Black taxpayers receive IRS audit notices at least 2.9 times (and perhaps as much as 4.7 times) more often than non-Black taxpayers
Because of that year-round organization, she wasn’t worried about the outcome. “I sat in the corner posting on Facebook and Twitter,” she says. “I don’t have time to worry about that. I’m going to work extra hard so I can afford to pay [my accountant].”
The audit took 45 minutes, and Brundidge ended up owing $1,900. The auditor had questions. For example, did she really give 10% of her income to the church? Yes, and she could prove it. The auditor also questioned why she expensed tickets to entertainment venues like The Children’s Theater.
“What they didn’t understand was that I have an entertainment company,” Brundidge says. Since three of her four children are on the autism spectrum, they produce a podcast that explores how different places accommodate children with sensory challenges. So that’s a legitimate expense, as was the visit to an autism-friendly Santa. Brundidge had the podcasts and receipts to back up her business deductions.
Not Everyone Is Forthcoming on Their Tax Returns
Even though the risk is low, you might think that the possibility of being audited would make people think twice before omitting or otherwise providing incorrect information on their tax returns. But it doesn’t. And perhaps part of the reason is that, while it doesn’t say this, the agency understands the temptation to, well, neglect to report some income and stretch the limits of deductible business expenses.
A recent study by Finder, a global financial comparison platform, revealed that one in six Americans (16%) had lied on a tax return(Opens in a new window). The survey further revealed a few juicy stats:
Men are more than three times as likely to lie on their taxes than women (24% compared with 7%).
Millennials are the most likely generation to lie on their taxes (28%).
Almost 100% of Americans within the $200,000-$250,000 income bracket admitted to lying on their taxes about side hustles, investments, or gambling.
“There are likely many reasons some taxpayers may not tell the truth on their returns, such as having cash income they believe is easy to hide, claiming personal expenses as business deductions, not understanding tax law, and making mistakes,” says Laura Adams, MBA, a personal finance expert with Finder.com.
Dishonest people may not realize how the IRS spots suspicious returns nor understand the consequences of being found at fault in an audit, she says.
Three Kinds of Audits
If the IRS does audit you, there are three ways it could go down.
1. Adjustment Letter
If you get an unexpected letter from the IRS, don’t panic, says Lisa Greene-Lewis, CPA and tax expert for TurboTax. It may just be an adjustment letter. You might get one of these if, for example, you neglected to report a small amount of income or interest. Since the IRS has copies of what’s reported, the agency will simply adjust your return and notify you.
2. Correspondence Audit
If the changes are more complicated, you might be asked to participate in a correspondence audit. In these cases, the IRS asks you to provide additional information about your income, expenses, and deductions. It happens through the postal mail.
3. In-Person Audit
If sending the requested data through the mail would be too complicated (say you have a large paper ledger or receipts that you don’t want to let go of), you can request an in-person audit.
The in-person audit is the one that makes some people break out in a sweat. It can take place either at an IRS office (office audit) or at your home, place of business, or your accountant’s office (field audit). The IRS provides a list of required documents in advance, and it accepts some electronic records(Opens in a new window) that are produced by financial software.
How Long Does an IRS Audit Take?
The length of time your financial life will be under the microscope depends on the complexity of the issues involved and how well you’ve prepared. It can have three conclusions:
No change means you have substantiated everything the IRS has questioned and no changes are recommended.
Agreed means the IRS has proposed changes and you accept them.
Disagreed means just what it sounds like. You understand the changes the IRS has proposed, but you disagree with them. In this case, you can ask to meet with an IRS manager. You can also request mediation(Opens in a new window) or file an appeal(Opens in a new window).
Of course, there’s always the possibility you could be assessed fines, penalties, and interest, which can be significant.
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Can Tax Software Help You Avoid an Audit?
There are a variety of ways taxpayers can avoid the likelihood of an audit. “Most of them come down to filing an accurate return,” says H&R Block’s Benson. For example, math errors, reporting incorrect amounts of income and deductions, and incorrect business return items can be red flags. Claiming too much in business losses or too many charitable donations could also spark further examination.
Using the best tax software may reduce your chances of being audited for a number of reasons. For example, they walk you through the tax preparation process to ensure you visit all the tax topics that pertain to your financial situation. They also provide multiple layers of help and don’t let you move on to a new page without finishing the last one, to prevent missing data. Tax apps also let you bookmark pages so you don’t forget to go back and complete them. They also simplify the language the IRS uses so you understand what’s being asked and how you need to respond. Lastly, tax software goes through your entire return before you file it to look for and report on errors and omissions, so you can fix them before filing.
Software Companies Provide Limited Audit Support
If after all your good faith efforts you still get audited, some tax websites offer services that can help you through the process. Some are more comprehensive than others. For example, H&R Block offers Worry-Free Audit Support for free when you file using the company’s desktop software, or for an extra fee if you file online. Taxpayers who receive Worry-Free Audit Support are eligible to obtain services from an Enrolled Agent (EA), but not a CPA or attorney. In other words, it’s not legal representation. EAs only provide tax advice. If you qualify, you receive:
Guidance on how to handle notices initiated by the IRS or state taxing authority regarding eligible returns. There are many situations that aren’t covered, like rejected or amended returns.
Information regarding IRS or state taxing authority audits, including what to expect and how to prepare for one.
Representation by an H&R Block EA during the actual audit should a tax authority question the accuracy of your return.
TurboTax offers a similar service through a third party (Tax Resources, Inc.) called MAX Defend & Restore ($59 at this writing). It includes identity theft insurance, monitoring, and restoration in addition to priority care and audit representation. Services are provided by tax experts, not CPAs or attorneys. Like the H&R Block audit service, there are many limitations and exclusions, so you should read the membership agreement(Opens in a new window) before you decide whether to sign up.
The Best Tax Software to Avoid Audits
For many years, TurboTax has won an Editors’ Choice from PCMag because it offers such an effective combination of comprehensive tax topic coverage, voluminous guidance, and an exceptional user experience. Used conscientiously and honestly, it gives you the best shot at avoiding an audit because it’s so thorough, understandable, and helpful.
Intuit’s Greene-Lewis had additional advice for individuals and businesses who are trying to avoid an audit, especially the self-employed. Make sure that you have receipts for everything you have claimed. This, of course, requires year-round attention to business expenses, something experts recommend. “Tax season is not just January through April,” Greene-Lewis says.
You can do this manually by stuffing paper receipts into carefully-organized files folders or big envelopes, or by using a personal finance app (like Mint or Quicken) or a small business accounting application (like Intuit QuickBooks Online or FreshBooks) that allows you to import transactions from your online bank and categorize them.
Greene-Lewis encourages self-employed people to take all the legal deductions they can, as long as they’re backed up by receipts. “If you’re claiming business travel, document the date and the reason for the trip,” she says. Same with business meals, since such expenses can be carefully scrutinized by the IRS. Claim dependents if you have them, but make sure you meet the criteria (you have to have provided over half of their support during the tax year, for example). In 2013, the IRS even created the Simplified Option for the home office deduction to make it easier for taxpayers to claim it.
“If an expense is directly related to your business, you should take what you’re owed,” she says. But she cautions that if you continue to show losses compared with what you’re making, you may be on the IRS’s radar. The IRS makes a clear distinction(Opens in a new window) between legitimate businesses and hobbies. And you can’t claim expenses for the latter.
The IRS also looks at norms, she says. If you’re making $40,000 and claiming $20,000 in charitable donations, she says, the IRS may flag that. TurboTax will, too.
If you use a TurboTax tax expert to prepare your return, they will not sign and file a suspect return. The company offers two levels of its TurboTax Live, a service that matches taxpayers who want to pay extra for expert help with CPAs, EAs, or other financial professionals. The interaction between the two parties is all virtual, done through chat or phone or video screen-sharing. Using TurboTax Live Assisted, you can prepare your own return but consult with your expert and ask questions throughout. The pro does a final review of your return.
If you choose TurboTax Live Full Service, you upload your tax documents, and your expert completes your review for you. Intuit makes extensive use of AI and machine learning to augment the experts’ tax preparation process and flag areas that might need special attention from the pro.
Should You Worry About An Audit?
The incidence of audits is incredibly low, even if you’re in a high-risk group. If you are, there are numerous ways you can get guidance from—or even get your entire return prepared by—a professional.
The best way to prepare for an audit is to do your taxes as if there’s already a meeting with an auditor on your calendar. It’s possible to get pulled in for a random audit, but if you’re following the rules, documenting your income and expenses conscientiously, and being cognizant of possible red flags, you should go into it with confidence.
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