Will Your Tax Return Be Audited?
Few things are more unnerving than
having your tax return selected for an IRS audit. The IRS uses that "audit
anxiety" to help keep taxpayers honest on their tax returns.
The TCMP
Audit
What determines whose returns will be picked for audit? A certain
number of unlucky taxpayers will be picked simply to help the IRS gather
statistics. The "TCMP" audit (Taxpayer Compliance Measurement Program) is
probably the most exacting audit. The taxpayer is required to substantiate every
number on his or her tax return. The results from these audits are used by the
IRS to compile statistical information that can be used for other audit
purposes. These statistical audits have been suspended until further notice, but
they could be reinstated at any time.
DIF Scores Count
Apart
from the TCMP program, your return will be evaluated based on your "DIF" score,
a set of IRS formulas known as the "Discriminate Function System." About
three-quarters of all returns audited are selected by the DIF computer, which
compares deductions, credits, and exemptions with the norms for taxpayers in
each income bracket.
While these formulas are kept very secret by the
IRS, you can count on having a higher audit probability if you fall into certain
categories or report certain things on your tax return.
What Interests
the IRS?
Some higher risk areas are -
- Tax shelters. Though most new tax shelter write-offs have been eliminated by
tax reform, old shelter deductions will continue to interest the IRS. Returns
with passive income and losses are certain to be scrutinized.
- Tax protests. Both the IRS and tax courts are getting fed up with what they
consider frivolous tax protests. If you file a return stating that you owe no
tax because the dollar is worthless or make some other such protest, you'll
probably be audited.
- High income. Because auditing higher-income taxpayers is likely to produce
more additional tax revenue than auditing lower-income taxpayers, this category
is targeted by the IRS.
- Certain occupations. Taxpayers whose occupations produce cash income, such
as taxi drivers and waiters, run a higher risk of being audited. Self-employed
individuals, particularly independent contractors, are IRS targets for the same
reason; they are more likely to have unreported cash income.
- No preparer or a problem preparer. If you have a complex return and prepared
it yourself or if your return was prepared by someone on the IRS's problem
preparer list, you are more likely to be audited.
- Certain deductions. The IRS has found it profitable to audit returns that
claim office-in-the-home deductions, travel and entertainment deductions, and
certain other write-offs where they feel taxpayers stretch the truth.
- Related party transactions. Taxpayers who involve family members in their
financial operations are more likely to be scrutinized by the IRS. Paying wages
to your children, lending money to relatives, splitting income among family
members, or running a family business will make the IRS more interested in your
returns.
Your Best Audit Defense
Between one and two percent
of all individual tax returns filed in any year will be selected for audit.
Higher-income taxpayers and those in target categories face a slightly higher
audit possibility than lower-income taxpayers.
Absent fraud or
substantial understatement of income, the IRS has three years from the due date
of your return to initiate an audit. Typically, most returns are selected within
two years of their filing date.
The best defense in an audit is a
two-part strategy:
(1) Have supporting documentation for all deductions
and credits, and
(2) See your accountant immediately upon notification that
you're being audited.
A professional can put your mind at ease, find the
information that the IRS wants more quickly than you can, and very likely will
save you money in the long run by getting a faster and more favorable conclusion
to the audit.
If we can assist you in any way in your tax and business
affairs, contact our office.