The Odds of Being Audited by the IRS

There are many factors the IRS uses in its software to determine which returns get audited. Although it does not share trade secrets with the public, tax professionals know the IRS does take a close look at tax return deductions that are disproportionate with reported income.

The IRS issues many different statistics of income, including the national averages for various tax deductions for taxpayers at certain income levels. For example, tax filers who had an adjusted gross income (AGI) of $100,000 and itemized deductions claimed, on average, a charitable contribution deduction of about $3,000 (3 percent). Whether deductions are charitable or for something else, if you are claiming deductions above or below national averages, make sure you have documentation to support the expenses. Once the IRS looks at one area on the return, it may decide to expand the scope and examine other areas as well.

Note: You also have to be careful with the national averages the IRS publishes. For example, the national average for a property tax deduction is $5,250 for taxpayers with an AGI level of $150,000. A property tax bill of this size might be normal in California or New York, but may be high in other states with lower property tax rates such as Utah.

The following circumstances can increase your odds of getting audited by the IRS:

Being self-employed (versus an employee) because of additional opportunities to make mistakes.
Having a Form 1099 mismatch – for example, when income reported by brokerage firm doesn’t match tax return.
Being a high income earner because the IRS earns a better rate of return.
Claiming a large non-cash charitable contribution.
Reporting a loss from a business activity that could be a hobby (no profit motive).

How Audits are Conducted by the IRS

Tax returns are selected for audit by the IRS using the following three methods (an audit does not necessarily suggest an error has been made):

Random selection and computer screening: sometimes, returns are selected based solely on a statistical formula.
Document matching: occurs when payer records, such as Forms W-2 or Form 1099, do not match the information reported.
Related examinations: returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.

An audit may be conducted by mail, or through an in-person interview and review of the taxpayer’s records. The interview may either take place at an IRS office (office audit), or the taxpayer’s home, place of business or accountant’s office (field audit). The IRS will notify you about an audit by mail or telephone, and will indicate the records that are needed. A letter from the IRS will follow a telephone contact, and the IRS does not notify via email.

Taxpayer’s rights during an audit include the following:

A right to professional and courteous treatment by IRS employees.
A right to privacy and confidentiality about tax matters.
A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.
A right to representation, by oneself or an authorized representative.
A right to appeal disagreements, both within the IRS and before the courts.
The right to pay no more than the correct amount of tax.

An audit can be determined, and concluded, in the following three ways:

No change: taxpayer has substantiated all items being reviewed.
Agreed: taxpayer understands and agrees to the changes proposed by the IRS.
Disagreed: taxpayer understands and disagrees to the changes proposed by the IRS: A conference with a manager may be requested for further review, and Appeals Mediation Programs are available, or an Appeal request may be filed.

Here is a diagram from the IRS that illustrates the audit process: