The Lowdown on Tax Audits

Tax preparers have completed a lot of returns since the season began and will complete a lot more before April 15 – but that's just the beginning for many accountants and their clients. In the weeks and months that follow, the IRS will select a lucky few for audits. Now is the time for tax preparers to refresh themselves on the basics, in the event any of their clients lose the IRS lottery.

Even preparers who have been through this before should note that the IRS revised its audit guidance in mid-February. Among the important guidance is the material on audit selection. Rumors have abounded for decades about what leads the IRS to choose a return for an audit, and although the Service won't give away all its secrets, it does give some hints. It says it applies random selection and computer screening, sometimes using nothing more than its own statistical formulas. It can also be very basic, performing simple document matches: When a 1099 or W-2 doesn't match the information on a return, expect a call.

The company you keep can also make a difference. The IRS says it will select returns for audit when it uncovers transactions related to other taxpayers – such as business partners or investors – whose returns have already been selected for an audit.

A Forbes article published last year highlighted some numbers that may catch the eye of IRS examiners. It took at look at average Schedule A deductions, keeping in mind that wide departures from these averages could be a red flag. A generous person earning $200,000 a year may indeed give away $10,000 to charity, but that would be nearly double the average for someone at that income level. Is a taxpayer trying to illegally inflate the amount of property taxes paid? Right off the bat, the IRS may take a look at geography, noting that high property taxes are more common in some states than others.

The IRS guidance goes beyond what can trigger an audit and describes the process itself, exploding some rumors along the way. The Service notes that many think that an audit automatically means a trip to a local IRS office. The guidance dispels that, explaining that sometimes audits can take place in the taxpayer's home or office or in the accountant's office. It also explains that the result of an audit is not necessarily the end: The government offers multiple appeals channels, which the guidance explains.

But What Are the Odds?
So you know the triggers, but how likely is it that you'll be audited? The IRS is not in the odds-making business, but that hasn't stopped others from calculating the possibilities. The NOLO legal website says that those in the $25,000 to $100,000 range have less than one chance in 100 of getting audited. After that, the odds start rising steeply. If you're pulling in $1 million to $5 million, the odds are about 1-in-20. Bill Gates and Warren Buffett beware: At the $10 million and more range, the odds are nearly 1-in-3.

An article in Kiplinger's had some other interesting data that is reassuring: If your return doesn't include income from a business, rental real estate or a farm, or employee business expense write-offs, the audit odds jump to 1-in-250. And if you are audited, the IRS policy, noted above, of not always requiring a visit to government offices is more prevalent than many may have suspected: 70 percent of audits are handled through the mail.

Something else to gladden your heart: One audit in seven results in a favorable outcome – no money owed to the government, said Kiplinger's. And audits can even be good news: In 2011, for example, 66,381 audits led to unexpected refunds rather than a bill.

But no matter what happens, a review of the recent guidance means a quicker and less-painful process for everyone.

 

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