Five common myths about the dreaded tax audit

Mandi Woodruff Yahoo Finance
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Filing taxes is punishment enough without the vague threat of an IRS audit looming over our heads. For understandable reasons, the IRS insists on keeping the ins and outs of its auditing process on the murky side. How will you catch the bad guys if you give them the rule book first?

But because of the sense of mystery around the process, it’s an area of regulation often misunderstood by taxpayers.

Here are a few common myths about the dreaded tax audit:

Myth #1: Only the wealthy get audited.

While it’s true that big businesses and the uber-rich are often targets of IRS tax probes, that doesn’t necessarily mean low- and middle-income workers are free and clear. The agency is increasingly relying on data mining and robo-audit systems to detect errors in tax returns, which has actually made it easier to go after small-fish taxpayers.

In 2013, the IRS audited more than 6.5 million taxpayers with an adjusted gross income of less than $1 million. And it audited fewer than 40,000 of those reporting $1 million or more.

One of the biggest reasons behind that discrepancy is the IRS’s move to pursue people who fraudulently claim the Earned Income Tax Credit, a juicy tax break worth an average $5,891 for a family of five earning less than $50,270 a year.  In 2012 alone, EITC fraud cost the government between $11.6 billion and $13.6 billion.

“If you really look at  the scrutiny of low- and middle-income wage earners, there is much more detailed scrutiny now than for those with investments and other sources of income,” says Susan Long, co-director of the Transactional Records Access Clearinghouse (TRAC), a database that tracks spending at the IRS, among other federal agencies. “It just takes less resources [to audit lower-income earners]. And in all fairness to the IRS, Congress hasn’t been exactly generous with budgets.”

And while the overall number of audits has been declining since 2010, the IRS has decreased the rate of millionaire probes more than other income brackets.  Auditing rates for the under-$200,000 income club fell by only 0.14% between 2011 and 2013, compared with a 1.63% decrease in the rate of audits of those making $1 million or more, according to the IRS.

Myth #2  An audit means you’ll have an IRS agent knocking down my door

What is this, 1985? If the IRS’s computer system flags your tax return, you’d be hard-pressed to get an agent to pick up the phone, let alone make a house call.

“The traditional IRS audit and someone showing up on your doorstep is a thing of the past,” says Melissa Labante, director of tax advocacy for the American Institute of CPAs.

For starters, they don’t have the manpower. Thanks to rounds of budget cuts, the IRS has had to reduce staff by more than 8,000 employees since 2010 with no sign of relief yet.  Congress recently ordered the agency to slash another $526 million from its budget in 2014.

And while the agency’s funding and employee count decrease, more and more Americans are filing taxes each year, nearly 146 million in 2013 alone, up from 138 million five years ago.

Of the 6.5 million audits conducted last year, only 362,500, or 5.5%, resulted in an actual field visit. If your return is flagged, you’ll most likely get a letter in the mail seeking additional information. From there, you can either answer by return mail or call them directly.

Myth #3 If I owe tax money, the IRS will be after me in a hurry

Rest assured, if Uncle Sam flags your return for suspicious activity, you will hear from them at some point — but probably not for a year or two...or more. The IRS actually has three to six years to go after questionable tax returns, and with personnel shortages, even taxpayers who willingly call them to sort out issues have a hard time getting them resolved.

Last year, more than 20 million phone calls to the IRS went unanswered, leaving just 61% of callers able to get through to a human being, according to the National Taxpayer Advocate, a nonporift group that helps consumers resolve federal tax audits. 

“The IRS is under-funded and under-staffed,” says George Papadopoulos, a certified financial adviser and certified public accountant based in Novi, Mich. “If a consumer calls the IRS, when they get through to a human being, they will likely just be told where to find the answer on the IRS website.”

Myth #4 If I file for too many deductions and tax credits, I’m setting myself up for an audit

Tax credits and deductions are there for a reason: to ease the tax burden for workers who need it most. Don’t let the threat of an audit dissuade you from applying for tax credits and deductions you’re justifiably due.

Despite the IRS’s efforts to crack down on Earned Income Tax Credit fraud, it is actually one of the most commonly overlooked deductions. Twenty percent of eligible workers have missed out on the EITC, which is worth an average $5,891 for a family of five and $475 for single-filers without children.

Home-office deductions are another oft-cited target for the IRS. But it’s an overblown fear that hardly applies today, when there are more than 42 million Americans working as freelancers and independent contractors.

“This was once the case, back when working from home was less common,” says Bob Meighan, vice president of consumer advocacy for Intuit, which owns Turbo Tax. “With millions of home offices running today, the system is far more accommodating for home office users. The important thing to remember: Make sure you keep your receipts and documents and only deduct legitimate business expenses... which means that the expense must be typical and necessary for your business.”

The bottom line: If you’ve earned a tax credit or can justifiably claim a deduction, do it. Just make sure you’ve done the research and know what you need to back up your claim first. For that, we direct you to this simple guide from the IRS itself. 

Myth #5 I’ve got my tax refund so I don’t have to worry about an audit.

Even if your tax return was accepted and you cashed your refund check, you’re still fair game for auditors.

The IRS uses a special matching system that tracks each taxpayer’s W-2s, 1099s and 1040 forms. If it turns out that you’ve under-reported your income, the system will eventually catch up to you.

“You could get your refund, and about one or almost two years later, if there’s a problem with your taxes, you’ll likely get a letter in the mail from the IRS,” says Papadopoulos.

As noted above, the IRS has three years to track you down, but in extreme cases of underreporting or tax evasion, they can basically come after you whenever they want.

And that’s not even the worst part. Any interest and penalties owed on your unpaid taxes will start accruing the day your taxes were due — not two years later when the IRS letter finally shows up in your mailbox. Two years of compounding interest and penalty charges will only add salt to the wound.

Papadopoulos has simple advice for taxpayers looking to work the tax system in their favor: “Don’t mess with the IRS.”

Have a question about your taxes? Send us an e-mail.

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