Tax payers tremble when the words “IRS audit” are mentioned. If you listen to radio and TV news or pundits that fear can be augmented this time of year, you’ll be left with the impression that there is a metaphorical gun pointing at all of us, just waiting to be fired whenever we file our 1040s.
The truth, according to IRS figures, is that the majority of American taxpayers have less than a 1% chance of being audited by the IRS. Most audits these days begin with IRS computers flagging something on a return that appears strange or incorrect. If a return is prepared accurately and honestly, the chance of an IRS audit is very low.
However, there are several ways you can increase your chance of having your tax returns audited by the IRS, however. Read on if you want to know what some of them are, so you can be prepared if you end up as one of the unlucky people who come under scrutiny.
Claim Huge Charitable Contributions
IRS rules require that you have complete before-you-file documentation of gifs to charities, churches, and other non-profits. This means that the cards you collect from Goodwill or Salvation Army donations must be filled in with dates and the items given, and letters you receive from organizations acknowledging cash gifts must reflect the donation date and be sent in the year the donations were made. All these documents must be filed safely away with your tax records before you sign and submit your return. If you claim a large number of charitable contributions, meaning either number of organizations you are donating to, and/or the amount donated, you are increasing the chance of becoming the target of a “correspondence audit.” In such a case, the IRS will send you a letter, demanding that you mail in the documents backing your various deductions. If your documentation is incomplete or inaccurate, the IRS can disallow the charitable deduction, which makes claims of large contributions a tempting audit target.
Take Deductions in Round Numbers
Life is messy and things rarely break neatly down into numbers ending with 0. If you claim on your Form 2106 that you drove 7,000 miles for business out of a total of 15,000 miles in a year, and claim on your Schedule E that the supplies purchased to maintain the rental property came to $800, you are practically daring the IRS to subject you to a correspondence audit demanding documentation to support the deductions claimed.
A good deal of preparing and submitting tax returns is providing the IRS with information they already know. W2 statements, payments you’ve received as an independent contractor, information about your stock sales, the interest you’ve earned from the bank, the interest you’ve paid to the mortgage company—all of these things have already been reported to the IRS by the other person or institution involved in the transaction. Basically, anything that’s income for you is in all likelihood a tax deduction for someone else, and you should assume they are claiming that deduction. That includes that supposedly “under the table” job you did that you didn’t get a 1099-MISC for. The IRS computers are very good at comparing what should be on your tax return with what is on your tax return, and if they find something missing, you are could find yourself facing an audit.
Fail to Report Foreign Accounts, or Income from Them
As mentioned above, the IRS computers are very good about comparing what should be on your return with what is on your return. This includes bank accounts, brokerage accounts, and trust funds you have authority over in foreign countries. The tax laws state that Americans and resident aliens of the U.S. are taxed on all income worldwide. You may not be required to report a given bank account under the Foreign Bank Account Rules, but that doesn’t mean the interest is tax free. Even if you think your bank account in Germany amounts to “peanuts,” you are inviting an audit (and far, far worse) by failing interest earned on it.
Be Rich and Successful, or Poor and Unsuccessful
Taxpayers who fall into a broadly defined middle income range of $25,000 to $200,000 annually, have only a 0.8% chance of having their tax returns audited, those who fall outside it have an increasing likelihood of being subjected to a correspondence audit or a full-blown “come pay us a visit at the IRS office” audit.
If you report no taxable income, or a negative figure (due to business losses, capital losses, or Schedule A deductions), your chance of being audited is roughly 3.4%. At the other end of the scale, taxpayers with income between $200,000 and $500,000 have a 2.7% likelihood of being audited, with that increasing to 3.55% for those with incomes between $500,000 and $5 million. Once you’re into super-rich territory, with incomes up to $10 million, the chance of being audited is 20.75%, and above that there’s a 30% chance you’ll be audited.
While the vast sums of potential tax dollars are certainly part of what drives the IRS to look more closely at high income returns, and the likelihood that someone with no income is merely trying to dodge taxes resulting in the same at the lowest end, it’s actually the complexity of such returns that draws the IRS’s attention. Returns with multiple K1s, an entire alphabet worth of schedules, and the use of obscure tax planning strategies all add up to the IRS auditors viewing these returns as places to mine for non-compliance gold.
The bottom line is that even if your tax return has elements to it that will attract IRS attention, you don’t anything to worry about if it’s correctly prepared and you’ve kept appropriate records. The more complex your return, or the more of the factors talked about in this article that your tax return reflects, the better it may be for you to seek professional help to make sure it’s done right.