The word “audit” makes most taxpayers nervous, and no one wants to be on the IRS radar for anything. But individual taxpayers may find solace in the fact that last year the number of IRS audits fell to an 11-year low. The IRS audit rate of individuals is approximately 0.84%, or about 1 of every 119 tax returns filed. IRS Commissioner John Koskinen attributes the low audit rates to budget cuts and reduced staff. As much as the IRS attempts to use technology in the audit process, they still need humans to perform the audits and fewer humans means fewer audits. But just because audit rates are low doesn’t mean that taxpayers and their advisors should become brazen and make ill-advised decisions when filing their returns. Someone is going to be audited, and you want to do what you can to decrease the chances of that someone being you.
The main thing to remember is that for almost every form you receive in the mail reporting tax information to you (such as a W-2 or 1099), the IRS receives a copy too. So if your W-2 shows that you earned $75,000 in wages and you list $50,000 of wages on your return, you are almost guaranteed to receive a letter from the IRS. This type of letter, known as a CP2000 Notice, is spit out by the IRS computers when the information reported to them from a third party (such as your employer or bank) doesn’t match what you reported on your return. A CP2000 Notice isn’t really an audit; it’s just the IRS’s way of letting you know that something doesn’t match up. Now if you didn’t report the income or reported the wrong amount, then you will have to pay the additional tax due. But if there is an explanation as to why the amounts don’t match, you have a chance to explain why the amounts are different.
Your risk for being audited increases if you have more income and deduction items on your tax return that the IRS can’t verify from third parties. In other words, the more numbers that you have to come up with on your own (such as business income and rental expenses), the more likely your return could be selected for audit.
And while individuals with higher incomes are more likely to get audited, it has more to do with how you earn your income and not how much income you earn. If you earn a million dollar salary and it is reported on your W-2, the IRS doesn’t need to audit that because they have a copy of the W-2. But if you earn a million dollars from various sources that the IRS will have difficulty verifying (such as multiple partnerships and rental properties), your chances of getting audited are higher than the person who earned a million dollars on their W-2.
If you keep good records and can substantiate the numbers on your return, then you really have nothing to worry about even if you are audited. But if you try to, as my father used to say, “gild the lily” (I think he actually butchered a Shakespeare line with that phrase), you have to be careful. If you do that and your return gets selected for audit, make sure you have a good CPA on speed dial.
Winners and losers from this past tax season:
Winners: Individuals that need to pay their taxes in cash. The IRS now allows individuals to pay their taxes in cash at over 7,000 7-Eleven stores nationwide. Slurpee anyone?
Losers: Attendees at the Coachella Music Festival who tried to mail their tax returns from the onsite “post office”. The post office there isn’t a real post office. Try e-filing next time.