Odds of Being Audited
The odds are low that your return will be picked for an audit. However, the number has been increasing, particularly with respect to high-income taxpayers.
Audit odds vary depending on your income, profession, type of return, type of transactions reported, and where you live. Individual returns are classified by all income items on the return without regard to losses. Professional or business income reported on Schedule C and farm income reported on Schedule F is classified by total gross receipts, and corporate returns are classified by total assets.
Your return may command special IRS scrutiny because of your profession, the type of transactions reported, or the deductions claimed. The chances of being audited are greater under the following circumstances:
- The information reported on your tax return does not match information received from third-party documentation, such as Forms 1099 and W-2.
- Your itemized deductions exceed IRS targets.
- You claim tax-shelter losses.
- You report complex investment or business transactions without clear explanations.
- You receive cash payments in your work that the IRS thinks are easy to conceal, such as cash fees received by doctors or tips received by cab drivers and waiters.
- Business expenses are large in relation to income.
- Cash contributions to charity are large in relation to income.
- You are a shareholder of a closely held corporation whose return has been examined.
- A prior audit resulted in a tax deficiency.
- An informer gives the IRS grounds to believe that you are omitting income from your return.
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Audit Overview
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When you file, the IRS checks your return for computational accuracy and clerical errors, such as a missing signature or missing or inaccurate Social Security numbers. To check whether you have omitted income from your return, the IRS will match your return against the Forms W-2 and Forms 1099 it receives from employers, brokers, payers of interest and dividends, and others who have filed information returns reporting payments to you.
If an error is found, or you have not submitted required attachments, you will probably be advised by mail of the corrections and of additional tax due, or you may be asked to provide additional information to substantiate tax deductions or credits. If you disagree with an IRS assessment of additional tax, you may request an interview or submit additional information. If you file early for 2008, are advised of an error, and the correction is made before April 15, 2009, interest is not charged.
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Types of Audits
An examination may be held by correspondence, at a local IRS office, or at the taxpayer's place of business, office, or home. An examination at an IRS office is called a desk or office examination; an examination at a place of business or home is called a field examination.
In a correspondence audit, the IRS sends you a letter asking for additional information about an item on your return. If the IRS is not satisfied with your response, you may be called in for an office audit. The IRS also notifies you by letter of mathematical or clerical errors you have made on your return, or if you have failed to report income, such as interest or dividends, that are shown by payers on information returns and matched to taxpayer returns by IRS computers.
The complexity of the transactions reported on a return generally determines whether a return will be reviewed at an office or field examination.
Most audits of individual returns are conducted at IRS offices. An office audit usually covers only a few specific issues which the IRS specifies in its notice to you. For example, the examining agent may only be interested in seeing proof for travel expense deductions or educational expenses.
Field audits generally involve business returns; they are more extensive and time-consuming than office audits and are handled by more experienced IRS agents. For self-employed individuals, most examinations are field audits at their place of business. It is advisable to have a tax professional go over the potential weak spots in your return and represent you at the examination.
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Preparing for the Audit
After an office audit is scheduled, the first thing to do is look over your return. Refresh your memory. Examine the items the IRS questioned in its notice of audit, and organize your records accordingly. Also check the rest of your return and gather proof for items you are unsure of. Assume that the agent will assess additional tax, but establish the range you will consider reasonable. You can always change your mind, but giving some thought beforehand to possible settlement terms will help you later when settlements are actually discussed.
You may authorize an attorney, CPA, enrolled agent, or other individual recognized to practice before the IRS to represent you at the examination without your being there. If you attend the audit, take only the records related to the items questioned in the IRS notice. Do not volunteer extra records; if the agent sees them, it might suggest new areas for investigation.
If you are concerned that there may be a problem of fraud, see a qualified attorney before you meet an IRS official. The attorney can put your actions in perspective and help protect your legal rights. In addition, what you tell an attorney is privileged information; he or she cannot divulge or be forced to divulge data you have provided, other than data used to prepare your tax return.
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Summary
- Returns are rated for audit according to a mathematical formula called the discriminant function system (DIF).
- The odds are low that your return will be picked for an audit. However, the number has been increasing, particularly with respect to high-income taxpayers.
- An examination may be held by correspondence, at a local IRS office, or at the taxpayer's place of business, office, or home. An examination at an IRS office is called a desk or office examination; an examination at a place of business or home is called a field examination.
- After an office audit is scheduled, the first thing to do is look over your return. Refresh your memory. Examine the items the IRS questioned in its notice of audit, and organize your records accordingly.
- You may authorize an attorney, CPA, enrolled agent, or other individual recognized to practice before the IRS to represent you at the examination without your being there.
