IRS Audits: Your Odds and Best Strategies
Your tax return is more likely to get plucked for examination than you think. Here’s what to do if it happens to you.
Richard Eisenberg is the senior Web editor of the Money & Security and Work & Purpose channels of Next Avenue and Assistant Managing Editor for the site. Follow him on Twitter @richeis315.
An individual's chance of being audited fell 7 percent in 2012 (the most recent data), according to an analysis by the Transactional Records Access Clearinghouse, based at Syracuse University. Roughly 1 in 100 returns were audited (think of this as the new definition of "the 1 percent").
(MORE: Secrets of Claiming a Home Office Deduction)
Your Audit Odds May Be Higher Than the Averages
But don't be lulled into a false sense of security. When it comes to tax audits, broad generalizations are almost always useless. Your true chances of being audited could be much higher than the latest statistics suggest.
Your 2013 tax return could be audit bait if:
- Your income was over $200,000. Taxpayers with incomes of $200,000 or more had an audit rate of 3.70 percent in 2012, nearly four times as high as those with lower incomes, says Joy Taylor, assistant tax editor at Kiplinger’s and author of the article “IRS Audit Red Flags: The Dirty Dozen.”
- You're self-employed. Taxpayers who work for themselves can claim a variety of write-offs that most employees can’t — from a home office to the business use of a car — and the IRS may have questions about their legitimacy. “Self-employed people are more likely to overstate deductions and fail to report self-employment tax,” says Barbara Weltman, contributing editor of J.K. Lasser's Your Income Tax 2014.
- Your itemized deductions were much higher than other taxpayers with similar incomes. The bigger the difference between your write-offs and the averages, the more likely your return could be flagged, though it’s impossible to say exactly how wide the gap would need to be to attract the attention of the IRS. Similarly, if your itemized deductions totaled far more than what you claimed in previous years, your return could trigger an audit, too, says John Vento, a New York-based certified public accountant and author of Financial Independence (Getting to Point X).
Average Itemized Deductions
Here are the average itemized deductions for 2011 charitable contributions and medical expenses, the most recent data available, from the tax analytical firm Wolters Kluwer, CCH, for selected levels of adjusted gross income:
$50,000 to $100,000 income: Average charitable contributions: $2,881; medical expenses: $7,376.
$100,000 to $200,000: Charitable contributions: $3,890; medical expenses: $10,003.
$200,000 to $250,000: Charitable contributions: $5,703; medical expenses: $16,814.
$250,000 or more: Charitable contributions: $18,490; medical expenses: $34,797.
How to Handle an Audit
Should you be notified that an audit is pending, don't panic. But don't ignore it either. “You can’t be an ostrich,” Weltman says. “It doesn’t go away and interest and penalties will continue to accrue, so you want to deal with the audit as soon as possible.” If the IRS decides you’re stonewalling, the agency can garnish your wages and put a lien on your property.
(MORE: Can You Write Off Your Hobby on Your Taxes?)
There are two kinds of audits:
Correspondence audit Far and away the most common — 76 percent of IRS audits in 2012, according to the Transactional Records Access Clearinghouse — this type is handled by mail.
Sometimes, these computer-processed letters have detected that you made a math error or your return didn’t match up with 1099 statements the IRS received from your broker, bank or mutual fund. “If you made a mistake and the IRS is right, just send in the money you owe and that’s the end of it,” Weltman says.
Sometimes, correspondence audits dispute a tax break you claimed and require you to pay additional taxes unless you can provide proof that you were correct.
In this case, if you believe you’re right, pull together the necessary documentation and send it back to the IRS through certified mail within 30 days, along with a letter that includes a copy of your correspondence audit and your “reference number” (the case number that appears in the letter you received). You could have your tax pro do this, but you'll have to pay him or her for this task. You can probably handle it yourself if the issue is simple and clear-cut.
Don’t have the necessary documentation?
“In some cases, you may be able to go back and get receipts,” Weltman says. “But in other cases, it may be too late. For instance, in order to claim a charitable contribution of $250 or more, you needed to get a written acknowledgment from the charity at the time you made the donation.”
If the IRS is right or you can’t prove your claim, send in the additional money.
If you think you deserve the tax break but it’s a gray area, it’s best to let the tax professional who prepared your return respond to the IRS, since he or she would likely be able to make a stronger case than you could. (If you didn’t use a tax pro, you may want to find one to take up your challenge.)
Field audits These are conducted in person at IRS offices or, in fewer and fewer instances these days, your home. “The IRS tries not to go into people’s homes the way it used to,” Taylor says. That’s because of the added expense and intrusion.
The IRS conducts these audits either when the agency has a variety of questions about your return or there’s a particular write-off that is too complicated to handle by mail. A field audit in an IRS office typically lasts two to four hours, Vento says, and may require follow-up visits or submission of additional documentation.
Random audit There’s a very slim chance that your return will be selected for what’s known as a “random” audit, which the IRS uses to find out if there are trends the agency should focus on to help it collect the revenue that’s due.
(MORE: New Tax Rules for Mutual Fund Investors)
If your return is plucked for this one, my condolences. A random audit is a kind of tax colonoscopy, “the most intrusive and detail-oriented," Vento says, noting that IRS agents can ask taxpayers for birth certificates and marriage licenses to verify their filing status.
It might be a year or two before you hear from the IRS about a field audit for your 2013 return.
If you’re summoned for a field audit, experts strongly recommend you have your tax professional handle it. Otherwise, there’s a chance you’ll say something at the audit that will open the proverbial can of worms and cause the IRS to demand even more taxes.
If you decide to go it alone or accompany your tax pro, behave professionally and don’t become argumentative. “You have to treat IRS agents with respect,” Weltman says. “They’re not out to get you. They just want to resolve open questions.”
Vento says: “You should be honest and truthful with your answers, but also be short and to the point. Typically, the more you talk, the more questions the IRS agent will have.”
Come prepared and organized. “If you arrive with a messy shoebox filled with a jumble of receipts, the agent may get a little upset,” Taylor says.
If you don’t have the necessary document, Taylor says, ask the agent what type of documentation you might be able to provide. For instance, maybe you claimed the business use of a car and didn’t keep receipts for gas and parking. It could be that showing the IRS a calendar of your business meetings might work as a substitute.
When the audit is over, if you disagree with the agent’s contention, you can ratchet up the system and go through the IRS’s appeals process. You’ll want a tax pro to handle this step.
When You Can't Pay What You Owe
If the audit finds that you owe the IRS more money but you don’t have the cash, you have three choices:
Pay with a credit card. But you’ll also need to pay the IRS a steep “convenience fee” of up to 2.35 percent.
Ask for an installment agreement. It’s a monthly plan that lets you spread your payments over as long as six years.
If you’ll owe less than $50,000, the IRS will let you apply online; you’ll need to submit Form 9465, Installment Agreement Request. For payments of more than $50,000, you’ll need to contact the IRS. There’s a fee of $43 to $120 for setting up the plan.
“There’s an incentive to finish the payments as quickly as you can, to limit the amount of interest and penalties you’ll owe,” Weltman says.
Request an “offer in compromise.” That’s the IRS term for when you believe you won’t be able to come up with the entire amount due and would like to settle your tax debt for less. Here, again, you'd be best to have a tax professional do this for you.
The IRS is pretty reluctant about granting these, although it began offering more flexible terms two years ago.
Just steer clear of companies that claim they can help you reduce your tax debt to “pennies on the dollar.” The Federal Trade Commission has found some of these firms to be scammers, bilking consumers out of millions of dollars.
It's bad enough if you’re audited and owe the IRS a chunk of change. Don't compound the financial mess by throwing money away on a bogus outfit.