Your Chances of Getting Audited by the IRS

It’s a topic no one likes to discuss – an IRS audit. But, is it worth discussing? What are the chances, as an individual taxpayer, of getting audited? Here’s some statistics and tips:

What are the odds? In 2015, about 0.8% of prior year personal tax returns filed were audited. Out of those, 39% were for returns that claimed the Earned Income Tax Credit (EITC). The number of returns being audited has been decreasing since 2010. Examinations of returns claiming the EITC, however, are increasing as a percentage.

How are returns selected for audit? All personal returns are run through the Discriminant Function (DIF) system. DIF uses confidential and undisclosed mathematical formulas to assign a score to each return. The higher the score, the more likely the return will be audited. It does not, however, guarantee an audit. The score merely indicates the potential. Returns with high scores are then manually reviewed. Screeners look at the return as a whole and evaluate the significance of each item. At that point, it’s determined whether the return warrants an audit or not.

Sometimes, returns are selected for specific reasons. For example, if the W-2 wages you report don’t match the amount your employer submitted to the IRS, it will trigger an inquiry. For more information on other methods of selection, go to https://www.irs.gov/uac/the-examination-audit-process.

The good news. About 78% of audits are correspondence audits, meaning you’re not going to have an agent knocking on your door. Documentation and other evidence to complete the examination is requested via letter. In return, you mail back copies of whatever they’re requesting. Telephone calls might be involved as well, depending on the situation.

For more complex issues that can’t be feasibly resolved by correspondence, an in-person interview at the nearest IRS field office may be scheduled.

The first step. If a personal return is selected for examination, the IRS will send an initial contact letter. They will not call or e-mail you. The letter will either 1) request information or 2) indicate a correction on the return and ask for your written agreement to the change. Corrections can be challenged, though, if you don’t agree.

What you can do. If you receive a letter from the IRS, the best thing to do is open and read it immediately. This will give you enough time to respond. Time limits are usually imposed so the sooner you read it, the more time you have to prepare and send your response by the deadline.

Read the letter carefully from beginning to end. Since most audits are of the correspondence type, odds are that the letter is requesting copies of certain documents be submitted via mail or fax. Make copies of the documents requested, write your Social Security number on each document, and include a copy of the letter with your response. If you plan on faxing, consult the letter to obtain the fax number and what information to include on the fax cover sheet.

If you’re stuck. If you’re still unclear on what to do after reading the letter, contact your tax professional or accountant immediately. It’s important that a response is given by the stated deadline on the letter so the issue doesn’t escalate.

Final thoughts. The odds of getting audited are low. If your tax return gets selected, however, open IRS letters immediately, read them carefully, and be timely and thorough when furnishing the requested information. It will facilitate a smoother process and it will be a lot less stressful on you. And when in doubt, always contact your accountant.

Getting Ready for Tax Time

Whether you do it yourself or hire a professional to do it, the key to preparing a tax return is complete and accurate information. This article is geared towards individuals who have a low to medium financial complexity. Let’s break down what you need in two simple categories: income and expenses. Please note that there are exceptions to everything and these are general, high-level guidelines. Consulting with a tax professional is always the best course of action to avoid mistakes and misstatements.

Income. Any money coming in the door usually has to be reported. Exceptions include, but aren’t limited to, child support received and life insurance proceeds. For the most part, you will be provided a form reporting your income. If you work for a company, you’ll receive a W-2. If you have investments and received a distribution, interest, dividends, or capital gains, you’ll receive some type of 1099. Unemployment income is reported on 1099-G. There are more income scenarios, but the point is that the work is done for you. Simply retain all tax documents you receive and report them in the proper section on your return.

If you receive alimony, you will not receive any type of form. You still, however, have to report it. Ex-spouses who pay alimony get to deduct the payments from their income. In turn, the recipient adds the same amount to their income. And yes, the IRS does check to see if the amounts match.

If you perform any part-time or full-time freelance work or have a sole proprietorship, all income generated from your work must be reported as income. In many cases, you’ll receive a 1099-MISC if a business paid you more than $600 in a calendar year. Business income is beyond the scope of this article, but I wanted to highlight the fact that all income is reportable regardless if you received a year-end form or not.

Expenses. It’s mostly up to you to track your tax deductible expenses for the year. You will, however, receive a 1098 for student loan interest paid and mortgage interest/property taxes paid. If you pay your property taxes directly, it will not be reported on the 1098.

Medical and dental expenses are one of the more common deductions. Keep track of payments made for non-employer health and dental plan premiums, doctor/dentist visits, lab work, radiology, and prescriptions. Retain bills and receipts to support your deductions. Payments made on a credit card DO count even if you don’t make a payment on the credit card until the next year. You may also deduct mileage for travel to and from medical and dental visits as long as you keep a log of your mileage. Items that aren’t deductible include over-the-counter medications (except insulin), vitamins, and personal care products.

The other common deduction is charitable donations. Monetary donations are deductible as long as you have written acknowledgement from the recipient of the donation. Canceled checks aren’t sufficient anymore. If you donate items, ensure you assign a conservative fair market value for the items. This is a hot button for the IRS so my recommendation would be to err on the side of caution and don’t be too aggressive with your valuation.

Finally, you may deduct money you spend on job-related expenses only if your employer did not reimburse you for those expenses. For example, if you work in construction and your employer gives you a $50 allowance to purchase work boots and you spend $75, you can deduct $25 on your return as a job-related expense. Mileage driven to and from work is not deductible.

I hope this brief entry helps make this and future tax seasons a little less stressful for you. As always, I recommend using a personal money management software, like Quicken, to track expenses. Not only is it a great tool to understand how you’re spending your money, but it generates reports to quickly obtain the numbers you need to complete your tax return.