Did you know that each year in the United States, the federal government and individual states audit hundreds of thousands of taxpayers? As intimidating as this process may seem, taxpayers do not need to worry if they are one of the unlucky few audited. It is important to understand who gets audited and why, as this may be an invaluable guide during tax season.
What is Tax Auditing?
Tax Auditing is a comprehensive evaluation of an individual’s tax return by either the IRS (Internal Revenue Service) or a state’s taxation department. This evaluation includes examining a taxpayer’s financial records and documents to ensure the accuracy of information and the legitimacy of deductions, credits, and other items claimed. The objective of the examination is to determine whether a taxpayer owes additional amounts in taxes or not.
Why Do Tax Authorities Audit Taxpayers?
Tax authorities audit taxpayers primarily to maintain the integrity of the tax system and to ensure that individuals are filing accurate tax returns. The process also identifies and corrects tax errors to prevent further noncompliance or legal action from taxpayers. Additionally, tax auditing identifies taxpayers who claim excessive or unsubstantiated deductions and serves as an effective deterrent for accurate reporting.
Types of Tax Audits
There are two types of tax audits: correspondence audits and face-to-face audits.
Correspondence Audits
Correspondence audits are when the tax authority contacts a taxpayer directly with a notification and requests additional information. This information between the tax authority and taxpayer is conducted through the mail and online. Common requests in correspondence audits include additional documents to confirm income, deductions, and credits.
Face-to-Face Audits
Face-to-face audits are more similar to criminal investigations and occur in the taxpayer’s home or place of business. During these audits, the auditor will ask questions and request specific documents to ensure the accuracy of the taxpayer’s information. These audits are typically reserved for more serious cases where there are plenty of irregularities.
Who Gets Audited?
The IRS audits taxpayers based on the audit selection process. Some people have a higher chance of being audited than others, as certain attributes can increase the likelihood of an audit. Below are the six primary factors that may contribute to being audited;
- Reporting Foreign Assets
Individuals required to report foreign assets to the IRS on a form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts) are at a higher risk of being audited. Failure to attach this form to a tax return will almost always guarantee an audit.
- Large Income
Individuals with higher incomes may be sent to the IRS for an audit. High earners are typically the most targeted group due to the belief that they have a tendency to underreport income and take excessive deductions.
- Self-employed Businesses
Business owners and self-employed individuals are more likely to be audited due to the availability of self-reported data. For instance, businesses that maintain income and downtime records are more likely to be targeted for an audit.
- Home Office Deductions
Claiming home office deductions can be beneficial for taxpayers, but also highly scrutinized by tax auditors. In order to qualify for a home office deduction, taxpayers must provide extensive information, such as the size of their home office and the purpose of their business.
- Unreported Income
If you neglect to report income on a tax return, you may be subject to an IRS audit. This is especially true if said income was provided by a large corporation or financial institution. The IRS has access to the income of taxpayers, so unreported income is easier to find.
- Multiple Dependents
Taxpayers who claim multiple dependents are more likely to be audited, as it is seen as an easy way to take advantage of a tax deduction. To qualify for a dependent exemption, the taxpayer must provide a Social Security Number (SSN) or an Adoption Taxpayer Identification Number (ATIN) for the dependent.
How to Minimize the Risk of an Audit
Although it is impossible to guarantee that you won’t be audited, there are certain measures to drastically reduce the risk of an IRS audit. Below are five tips to help you reduce your chances of an audit:
- File an Accurate and Complete Tax Return
Accurate and complete tax returns reduce the red flags for an audit. You should double-check all information, including income, credits, and deductions. You may even consider using a tax filing software to ensure accuracy.
- Report all Income
It is important to report all income and not underestimate your earnings to avoid an audit. Without having a clear record of income, you could be left in a difficult spot during a tax audit.
- Take Justified Deductions
Excessive deductions and credits may result in an audit. For instance, discrepancies between itemized deductions and the industry standards may draw suspicion. Be sure to understand the circumstances and qualifications of the deductions you claim.
- Avoid Too Many Amendments
Unfortunately, amending your tax return can put you at risk for audit. Unless substantial errors are found on a tax return, it’s best not to amend the return at the last minute.
- Ask for Professional Help
For tax returns with more complexities, such as those with multiple investments or deductions, tax preparation professionals may be sought. An experienced tax preparer will count the benefits and accurately complete the tax return form.
Tax audits are a natural part of the taxation process and are necessary for the efficient and effective operation of the IRS and other tax authorities. While it is difficult to guarantee that you will not be audited, understanding who is most likely to be audited, and following the tips of minimizing risk can be beneficial. Ultimately, taxpayers should always keep accurate and precise records to minimize their chances of an audit.
