What Triggers An IRS Tax Audit?

by Ron Haynes

pay your taxes!Few things in life are more scary than a tax audit. If you’re like me, even if you’re relatively sure you did nothing wrong, when you get one of those envelopes in the mail your stomach tightens, and you feel just a little light headed. The key is to do whatever it takes to make sure you have everything in order regarding your taxes, that you maintain good records of income, expenses, and deductions, and that you have been accurate in your calculations. But what causes some returns to be audited and others to be accepted without question?

Criteria for IRS tax audits

1. You just didn’t pass the computer’s “smell” test.
Your return may be selected for what the Internal Revenue Service calls “an additional examination” on the basis of computer scoring. A computer program called the Discriminant Inventory Function System (DIF) assigns a numeric score to each individual and select corporate tax returns after they have been processed. Drastic changes in income is one way to increase your DIF score and trigger an audit because, the way the IRS looks at it, you may have under-reported your income LAST year. If your return is selected because of a high score under the DIF system, the potential is high that an audit of your return will result in a change to your income tax liability. In general, the IRS will audit returns that have a high potential for a return on the examiner’s time!

2. You made how much last year?
Your return may also be selected for “additional examination” on the basis of information received from third-party documents (think 1099′s and W-2′s). If these numbers don’t match the numbers you reported on your tax return, the IRS will question what you did, what you reported, and why. Your reported income should match the lifestyle you live. Living like a pauper but reporting income like a king is okay, but living like a king and reporting income like a pauper is a quick ticket to the audit office.

H&R Block offers free audit support AND audit representation as part of their guarantee.

3. Your nasty neighbors can turn you in!
In addition, your return may be selected as a result of information received from other sources on potential non-compliance with the tax laws or inaccurate filing. This information can come from a number of sources, including newspapers, public records, and individuals. Although the information is evaluated for reliability and accuracy before it is used as the basis of an examination or investigation, keep that in mind if you’re given to bragging about how much you scored in Atlantic City over the weekend. I’ve also heard of people turning in those who boast about cheating the IRS.

Which tax returns are more likely to get audited?

The IRS does look at certain characteristics of individual returns where taxpayer:

  1. Claimed the Earned Income Credit
  2. Returns with Schedule C (business profits and losses)
  3. Returns with Schedule E (supplemental income or loss)
  4. Form 2106 (used to report employee business expenses)

These items are more likely to be examined by the IRS. Don’t be afraid to file the proper schedules and forms if you have legitimate expenses and you are legally allowed to take them, but DO be aware that these are more closely scrutinized.

What steps should you take to avoid a tax audit?

Accuracy, accuracy, accuracy. An inaccurate return has a much higher chance for “additional examination.” So always insure the accuracy of your return. I have personally used H&R Block Online’s tax preparation software for well over a decade. I’ve found it to be easy to use, reliable, and able to handle any tax problem I’ve thrown at it over the last 15 years. There have been several years where my return was extremely complicated and H&R Block Online worked like a charm!

Next, make certain you report ALL your income, W-2 income, income from rental property, and any 1099-MISC non-employee income. If there is any income associated with your Social Security number, you better report it! Also, be sure to include any tips or cash payments you received for work or sales as well as the value of any services you barter. And don’t forget any hobby income, too. Under-reporting your income just because there are no official documents can come back to bite you.

H&R Block’s “Worry Free Audit Support” helps you understand why you’re being audited and what kind of response to prepare. They will even communicate on your behalf with the taxing authority.

Finally, make sure your deductions are in order by keeping detailed and accurate records. If you have some unusual deductions (either in type or amount), get photographs to substantiate them. If you have some unusually high repair costs to your rental property because of tenant damages, photographs will help your case in the event of an audit to your taxes.

If you deduct the expenses of an independent contractor (lawn services for your business, SEO work for your blog), you must issue a 1099 unless the payment was less than $600.

If you’re deducting non-reimbursed employee expenses, use whatever method is conventional in your industry. The IRS is flexible on these deductions so long as your method of calculating them is consistent with others in the industry. Some industries deduct mileage, for example, while others deduct actual expenses associated with travel. Whichever method you choose, be consistent.

TurboTax vs H&R Block Online – which one is better?

A tax audit isn’t the end of the world and if you get a notice that you’re being called into the local office, or an examiner plans to visit your home or business, or you’re simply supposed to respond by mail, give the IRS the information it requests without reservation. Some audits are random, but most are the result of statistical comparisons to the norm. Even though large deductions can trigger an audit, you DO have the right to take all legitimate deductions and the right to appeal any decision the examiner makes if you don’t agree with it.

photo credit: j2dread

About the author

Ron Haynes has written 1001 articles on The Wisdom Journal.


The founder and editor of The Wisdom Journal in 2007, Ron has worked in banking, distribution, retail, and upper management for companies ranging in size from small startups to multi-billion dollar corporations. He graduated Suma Cum Laude from a top MBA program and currently is a Human Resources and Management consultant, helping companies know how employees will behave in varying situations and what motivates them to action, assisting firms in identifying top talent, and coaching managers and employees on how to better communicate and make the workplace MUCH more enjoyable. If you'd like help in these areas, contact Ron using the contact form at the top of this page or at 870-761-7881.


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{ 22 comments }

Bobbi D

Great post. I hope I never get that envelope. Of course, now I probably jinxed myself, LOL.
Thanks for the insight into this issue. :)

Admin

As I understand it, there is a slight bit of randomness to their selection for an audit, but that’s a very small chance. Just keep good records, be honest, and you’ll be okay. :)

David James

Glad to hear you use TaxCut. Also wanted to let you know that in the event that you are audited and you use TaxCut, you are covered with Worry-free Audit Support. This is live assistance from an experienced H&R Block tax professional, up to and including representing you before the IRS.

David James
H&R Block TaxCut

Admin

Hey David!
Thanks for stopping by my blog and leaving that tip about Worry Free Audit Support. I have used TaxCut for about 12 years now and I absolutely love it. One of the things I really like IS the audit support. It’s nice to know I “have people” in case I need them!

You guys are great! Thanks again.

wyche128

Make sure you keep all important documents for 3 years. I am the credit manager at an Insurance Replacement Company and we have been audited twice. Not that big of a deal but make sure you have all the documentation.

Debt Education Alliance

SimplyForties

Happy New Year, Ron!

My accountant, who used to work for the IRS says that you are less likely to be audited if you file in the 2nd or 3rd quarter of the year as opposed to filing on April 15th. Who knows?!

Admin

You know, that’s not the first time I’ve heard that one. Makes sense though. Probably the IRS is so busy with the gazillion returns filed in April that they already have their schedules set for quite some time!

Dan Massicotte

Hey Ron,

As you know, there is a sure and certainly a big temptation for bloggers to report less than they actually made.

Thank you for keeping this in the back of our minds. Honestly always pays in the long run.

Admin

Having a separate business checking account helps!

Dan Massicotte

I’ll remember that for when my blog takes off. I’m really happy right now since I just got my PR to 1…from 0. This is really getting me going right now.

IRS - Deductions

That’s a nice post. Thank you for sharing very useful information.

Mike Habib

What are the chances of being examined? A total of 1,391,581 individual income tax returns were audited during FY 2008 (Oct. 1, 2007 through Sept. 30, 2008) out of a total of 137.8 million individual returns that were filed in the previous year. This works out to 1.0% of all individual returns filed (about the same as the audit rate for the preceding year).

Ron

Since the IRS has hired over 15,000 new auditors, and since there are fewer tax filers since the recessions started, and since the IRS has been re-energized by the current administration and since the IRS has developed and continues to develop more sophisticated methods and technologies, those odds are expected to increase. The best bet is to avoid behaviors, incomes, or deductions that increase your chances of being audited in the first place.

Mike Habib

What are the chances of being examined? A total of 1,391,581 individual income tax returns were audited during FY 2008 (Oct. 1, 2007 through Sept. 30, 2008) out of a total of 137.8 million individual returns that were filed in the previous year. This works out to 1.0% of all individual returns filed (about the same as the audit rate for the preceding year). >

Rob

Thanks for these tips. Doing all I can to avoid an audit this year.

John Dailey

The information in the above was very helpful. Thanks!

Tim

What are the penalties? What happens if IRS audits someone (either by random or system alarm) and find error? Will they just ask to make correction & send it again or there is penalty, future consequences, prison, etc?

Ron

The IRS simply wants its money. Prison is usually reserved for the most egregious crimes where someone owes a ton of money but for the average citizen, simply send in the money and you’ll probably avoid the big house. You won’t avoid interest charges and penalties however. Those are listed on the IRS website and they can vary depending on the amount owed.

Your best bet is to immediately come clean and work with the IRS to resolve any issues they have with your return. Always return those phone calls and reply to those letters.

Bill

What about state audits? Are the criteria similar for triggering an audit for state returns? Who handles audits in the states? And, are any states in particular more or less audit-happy? What about Wisconsin?

Thanks for all the great info…

Ron

Most states have a penchant for following the IRS’s lead on a lot of policies so I would assume that audit triggers would be the roughly the same. State audits are handled by the state Department of Revenue. I did a quick search and couldn’t find out if one state was more audit-happy than another but I would wager than states with a budget problem are going to invest more resources in audits than those with a budget surplus!

Jeff Fitzhugh

They rape us with taxes. The FICA tax is a rip off and eliminating the Federal Reserve would solve that problem. Then the money used when they give our money to other countries. The money given in free grants. The only hope is educated people and it’s occurring, but not fast enough. What price tag would you put on that?

Tamara

Thanks for the info., it’s very helpful. I have a tax bill that came about after doing my own taxes online with turbotax. At the time I was a f/t independent contractor working from home & also taking classes full time- getting a prof certification that year (2007) I began to make payments to the IRS. Then stopped after having an accountant do my taxes the following year where he was able to zero it all out. It was obvious to me that I did something wrong so I had him review ’07 filing. I was told I def should get it “amended.”
my question is, am I likely to get audited if I try to amend at this point? (Yes, I still owe for ‘o7 & now also for ’10, due to a foreclosure.) Should I just suck it up or will it be obvious that I’m amending because I did it myself that year?

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