Overall, the odds are reassuring. The vast majority (99%, in fact) of individual income tax returns skate safely past the IRS audit machine.
Better news: The 1-in-100 chance of being called on the carpet really overstates the severity of the situation. Fully 70% of all audits are handled by mail, not by mano a mano combat with an IRS agent. And, if your return doesn't include income from a business, rental real estate or a farm, or employee business expense write-offs, the basic 1-in-100 chance of being challenged jumps to 1-in-250.
Another piece of rarely reported good news: Each year, tens of thousands of taxpayers walk out of an audit with a check from the government. In 2011, for example, 66,381 audits resulted in refunds totaling over $1 billion.
[TOOL: Calculate Your Risk of an IRS Audit]
The 1-in-91 chance of being audited is the overall average. Your actual odds turn on the kind of return you file and the type of income you report.
Our calculator, based on official IRS data on returns audited in 2012, will give you a good idea of the odds that your personal 1040 (or 1040-A or 1040-EZ) will be selected for review — either by mail or in person. And, remember, even if it is, there's a 1-in-7 chance you'll walk away unscathed or be one of the lucky ones whose audit results in a refund.
With few exceptions, of course, the IRS doesn't randomly choose which returns to audit. The few thousand random reviews each year are performed to help the IRS calibrate the computers that identify the juiciest targets.
Over the next few months, the IRS will be plugging data from more than 140 million tax returns into a computer that scrutinizes the numbers every which way and ponders how the picture you paint of your financial life jibes with what it knows about other taxpayers. The computer tries to spot returns that are most likely to produce extra tax if put through the audit wringer. The computer's choices are reviewed by a human being who can overrule them if, for example, an attachment to your return satisfactorily explains the entry that set the computer all atwitter. Short of such a veto, your name will go on the list.
Even if your return survives the computer's scrutiny, you're not necessarily safe. You may have listed an investment in a tax shelter the IRS is particularly interested in, for example, or the agency might decide to take a closer look at your return because it smells of the latest scam du jour identified by the IRS.
And there's always the chance that someone has fingered you as a tax cheat. The IRS encourages such tips and even pays a bounty for leads that pay off in extra tax.
Whatever the reason you're chosen for an audit, it's chilling to get the word that the IRS wants to examine your return. After all, everyone knows that the IRS was able to do what J. Edgar Hoover and all the G-men of the FBI couldn't do: put Al Capone behind bars. Even if you have no reason to think you did anything wrong, you can't escape the anxiety that accompanies an audit notice. For one thing, the return being audited is unlikely to be the one you just filed. A lot of taxpayers are only now hearing from the IRS about their 2011 returns ... and some 2010 returns are just coming up to bat. (Generally, the IRS has three years from the due date of your return — until April 15, 2016, for 2012 returns — to initiate an audit.)
How It All Begins
You'll get a letter announcing your fate. The simplest audit — a correspondence audit — requires only that you mail in the records needed to verify a specified claim on your return. In a field audit, an IRS agent comes to your home or place of business to go over your records. Most common, though, are office audits, which involve getting yourself to a local IRS office. You'll probably have at least a couple of weeks to prepare. If the appointment is set for an inconvenient time or you find that you'll need extra time to pull your records together, call the IRS promptly to request that the audit be rescheduled.
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The written notice will identify the items on your return that are being questioned — usually such broad categories as employee business expenses or casualty losses — and outline the types of records you'll need to clear up the matter. Office audits are usually limited to two or three issues, so you won't be expected to haul in all your records. What kind of evidence do you need? Here's how a retired IRS official with 30 years of auditing experience answered that question: "I expect to see the records you used when you prepared the tax return. You must have had some. Otherwise, how did you know you gave $5,000 to charity?"
Also, beware that auditors are sometimes looking for more than proof of what's on your return. They're also interested in whether income that should have been reported was left off. That could mean a review of your bank records, for instance, in search of deposits that might represent unreported income.
The best way to begin preparing for your meeting is to pull out your copy of the return being audited. Before the IRS puts your forms to the test, do the job yourself. Pore over the items being questioned and pull together the documents that support your entries. Of course there will be gaps, but don't automatically concede defeat. Try to reconstruct missing records.
- If, as luck would have it, you can't find the return, call the IRS office that contacted you and ask how to get a copy.
- Get copies of canceled checks from the bank or duplicates of receipts or written statements from individuals who can back up your claims.
- If you can't come up with written evidence for certain entries, prepare an oral explanation.
Your records needn't be perfect. If you can reasonably explain how you came up with a figure that's not fully corroborated by the evidence, the IRS may well accept it. The IRS likes to stress how reasonable audit personnel are. However, when you're pulling together your records, remember this: The more thorough your documentation is in general, the more likely an auditor will cut you some slack on an occasional point.
Do You Need Help?
You don't have to go to the audit at all. You can avoid it by hiring someone to go in your place. Such a representative must have written authorization to act for you, and the IRS provides a power-of-attorney form — Form 2848 (pdf) — for this purpose. Whether you go alone or hire a representative to go with you or in your place depends primarily on the issues involved. If they're relatively simple, cut-and-dried matters, you may be able to settle things without help. When matters are more technical or require interpretation of the law, however, it's more likely you'll need assistance. You have to make this judgment, and it will turn in part on how you feel about going head to head with the IRS. If you're scared, by all means get someone to go with you or in your place.
If someone else prepared your return, let him or her know about the audit and ask for tips on how to get ready for it. Whether you want this person to go along may depend on the cost to you. Although the IRS prefers to wrap up cases with one meeting, if you don't agree with the auditor's conclusions or need time to round up extra evidence, you can schedule a follow-up meeting. Unless you fear you might capitulate if you go to the audit alone, you may want to try to settle as many issues as you can by yourself.
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If disagreements remain and the amount of money at stake justifies the expense, you can take an adviser along to the next session. That way you'll have help when you really need it but won't have to pay for hand-holding while you clear up routine matters.
And note this: The Taxpayer Bill of Rights (pdf) gives you the right to stop an audit in its tracks if you decide you want representation. If the audit begins to veer off of the topics you are prepared to discuss, for example, you can call a halt to the proceedings and seek help if you need it.
The Big Day
The key to success is being well prepared. Forget the old slapstick routine of dumping a box of canceled checks and ratty receipts on the auditor's desk. That suggests your records are sloppy, and that's the last impression you want to give. Remember, it's up to you to back up the information on your return. The better organized your records, the more smoothly things will go.
Establish credibility right from the start. If you do, there's a better chance a gap later may be overlooked. Say that the audit notice states that your interest deductions, charitable contributions, and travel and entertainment write-offs will be reviewed. If you're solid on interest and contributions but shaky on T&E, try to steer the audit to your strong suits first.
Don't go into the session looking for a fight, but don't equate being cooperative with giving in whenever the auditor raises an eyebrow, either. If the agent tells you your records don't substantiate a deduction, for example, ask what might suffice. Perhaps you can mail it in later.
Don't chat your way into a problem. Keep in mind that the agent is trained to zero in on tax issues. A comment you consider totally unrelated to your return might lead you into a thicket. Defending a deduction by saying you've taken it in the past, for example, could prompt a review of previously filed returns; discussing the family's cross-country driving vacation might lead the agent to recalculate the ratio of business/personal miles for your car; or bemoaning the problems that led a child to drop out of college could cost you a dependency exemption. Fear that taxpayers will talk themselves into trouble is the key reason many advisers recommend sending a representative rather than showing up to the audit in person.
Cutting a Deal — or Not
If you do go, above all, keep your wits about you. Don't be pressured into settling an issue just to bring the audit to an end. The IRS argues strenuously that it doesn't judge its agents on how much extra money their audits produce. Even so, the fact is that one of the best guides to an agent's efficiency is the amount of additional tax he or she generates without going through all the formal assessment procedures or litigation.
Also remember that there may be room for compromise on the issue at hand. It may save time and money all around to agree on some in-between point or even for one side to give up on one disputed item in order to win on another.
Most office audits take from two to four hours. You'll spend a lot of that time watching the agent crunch numbers. When it's over, you'll get the auditor's decision — usually that you owe more tax. He or she should explain each proposed change to your return and the reason for it.
If you agree, that's fine. But remember that the auditor doesn't have the final say. Often, in fact, auditors make mistakes that cost taxpayers money. If you disagree with a finding, tell the auditor so and restate your position. He or she may be willing to compromise to close the case promptly.
You have several options if you opt to fight on. Even if you've handled things by yourself so far, at this point you may need professional help. You can ask for another meeting with the auditor to present additional evidence, or you can make an informal appeal to the auditor's boss. If you're still unhappy, you can go to the IRS regional appeal level. Or, you can take your case to court.