10 Myths About IRS Audits


This is how we usually imagine an IRS audit would go. But it's not the truth. eric1513/iStock/Thinkstock

When I think about taxes one of the first things that comes to mind is those old TV shows where the dad is up to his eyeballs in a mess of paperwork. We see calculators strewn across the table and endless trails of paper tape as he desperately tries to sort out his taxes in time for April 15.

This scenario doesn't really happen anymore, thanks to tax filing software, accountants and computer files. So while filing taxes isn't exactly the most fun thing to do, it's certainly not as stressful as it used to be.

However, there is one part of the tax process that causes many people to still wake up in a cold sweat in the middle of the night: tax audits.

Cue scenes of auditors slapping some handcuffs on you and taking you off to jail.

In reality, that's unlikely to happen. There aren't any debtors' prisons in the U.S. But what could happen to you? And how does the IRS know who to go after?

It doesn't help that the IRS is pretty tight-lipped about its tax auditing process. Can you really blame the agency? Why would it give away the playbook?

The good news is there is more information available than ever before. In the next 10 pages, we'll separate fact from fiction to help calm your nerves about potentially being audited. Let's start with the most obvious myth.

10
The Auditing Process Is Always a Nightmare
Indigestion or IRS-induced heart attack? Relax. Most of the time an audit is just a request for clarification. lisafax/iStock/Thinkstock

Not always true. In most cases it's not even remotely true.

The first thing you have to understand is that there are different kinds of audits. A mail audit is simply the IRS trying to verify a specific line item, and it involves you mailing in all of the support documents for that particular figure [source:Colorado Bar Association].

If you can prove the number is correct, then it should lead to a quick and hassle-free conclusion.

Mail correspondence is the most common form of auditing these days, with about 76 percent of audits occurring in this way [source:Ellis]. The other form is an in-person audit where an IRS agent will request an appointment with you to provide certain financial information

That being said, whether or not the auditing process is a nightmare also has a lot to do with you. If you're organized with your financial records, it will be a lot less hectic than if you don't know where anything is.

9
Audits Always Mean You Have to Pay More Money
Budget pressures forced the IRS to cut its investigators to its lowest number in four decades in 2014. Criminal investigative division chief, Richard Weber, said his goal was to get the number back up to at least 3,000, from around 2,500. © LARRY DOWNING/Reuters/Corbis

In the IRS publication "Know Your Rights As a Taxpayer" it explicitly states that taxpayers have the right to pay only what is legally due, and to have the IRS apply all tax payments properly. As such, they are not after you for more money than you owe.

According to Eric J. Nisall, a South Florida- based accountant who specializes in helping freelancers and small businesses, in some instances, the IRS may actually find deductions that were missed and could have been taken.

If you are wondering whether or not this rule about paying only what is due is enforced, in 1998, Congress passed the Internal Revenue Service Restructure and Reform Act (aka the "Taxpayer Bill of Rights") as a means of making sure the IRS treated taxpayers fairly [source:U.S. Government Printing Office] . Among its many provisions, the IRS can't seize someone's personal home to satisfy a liability of $5,000 or less.

8
It's a Common Occurrence
T. McKnight looks over forms as she prepares to file for a tax extension in New York City, 2007. Mario Tama/Getty Images

Audits don't happen as often as one would think. In fact, according to IRS examination statistics, the agency only audited 1.4 million people in 2013.And that's down 5 percent from 2012. It's also the lowest number of audits since 2008. While 1.4 million people may seem like a lot, it's really only 1 percent of all taxpayers [source:Ellis].

Here are the 2013 audit statistics, according to the IRS:

  • 0.88 percent of the people who earned less than $200,000 were audited
  • 3.26 percent of the people who earned more than $200,000 but less than $1,000,000 were audited
  • 10.85 percent of the people who earned more than $1,000,000 were audited

So, no, audits are not a common occurrence at all. Some speculate that they will happen even less often as the agency continues to lose funding and, as a result, employees. The IRS budget has been reduced by $1 billion since 2010, and it has cut around 10,000 employees. As you can probably imagine, this makes it more difficult for the IRS to keep up with its workload and to audit as many people as it might like to [source:Ellis].

7
You Have to Make Big Money to Be Audited
You don’t have to be a millionaire to be audited. The IRS audits people in all income brackets. Andrea Chu/Digital Vision/Thinkstock

While it may be true that big businesses and those earning large incomes are usually targets for IRS probes, this doesn't necessarily mean that those residing within low or middle-income brackets won't get audited.

The percentage of audits on low- to middle-income taxpayers steadily increased from 2006 to 2012, although it dropped in 2013 -- as did the percentage for every income group [source: IRS]. Simply put, it requires fewer resources to go after middle income people and as we stated previously, the IRS has been losing funding.

Additionally, the IRS has been cracking down on taxpayers who fraudulently claim the earned income tax credit, a big tax break worth an average of up to $6,044 for a family of five earning less than $51,567 a year [sources: Woodruff, IRS].

6
If You Use an Accountant, You Won't Be Audited
Shannon Philbrick, dressed as the Statue of Liberty, waves a sign at drivers to encourage them to come to Liberty Tax Services to get their taxes done. Most of the tax preparers at places like these are not accountants. © RICK WILKING/Reuters/Corbis

Whether you use an accountant, a tax attorney, an enrolled agent or your own elbow grease to do your taxes has no bearing on the selection process for audit. Audits are generally selected by computer program, and there is no place on the return to indicate what qualifications the preparer possessess.

The selection criteria used for audits is safeguarded by the IRS; however we do know that it's based on certain factors, such as comparing your charitable tax deductions to that of someone with the same salary. Another red flag is filing a Schedule C (profit or loss from a business) or E (profit or loss from rental real estate, royalties and S corporations). People who file these have a greater chance of getting audited. We'll explain why later.

However, not knowing the difference between an accountant and a tax preparer can lead to hot water if you deal with the wrong person.

Many tax preparer services compete on the ability to get you the biggest return possible. The preparers are not accountants and have only minimal training in tax preparation. As a result, they sometimes get a little carried away in trying to get you more money than perhaps you're entitled to [source: Pinola].

Furthermore, fly-by-night tax scam operations are extremely common during tax season, particularly in low-income neighborhoods. These preparers partake in purposeful fraud, and often, people don't understand what is being put on their return.

Therefore, you must use a credible accountant and avoid being blinded by the "We'll get you the biggest refund!" signs.

5
Self-employed People Get Audited More
Just because you have your own business doesn't mean you're more likely to be audited. But filing a Schedule C does raise the chance a little bit. Szepy/iStock/Thinkstock

Well, that depends on your definition of self-employment.

"Anyone who doesn't work for another person or entity is self-employed," points out accountant Nisall, which doesn't mean they are automatically targeted. "What people usually mean is that 'Schedule C businesses get audited more often,' and that is true to a degree."

According to Nisall, returns with a Schedule C are selected at a higher rate than those without them, and for good reason. A sole proprietor is the business and vice versa in the eyes of the IRS. What that means is that there is not a distinction between the two as there is between a shareholder and the incorporated entity he or she owns a part of.

This makes it very easy for comingling of funds and using those funds for personal gain. And, because so many sole proprietorships are cash-based and don't require large office accommodations, it's very easy for the proprietors to fail to report cash income and take liberties with household expenses as business deductions.

Even so, the chances of getting audited because you attached a Schedule C to your tax return are incredibly low – about 3 percent [source: Nitti].

4
The IRS Will Take Everything and Put Me in Jail
No need to worry about handcuffs: The IRS won’t haul you off to jail -- unless you are found guilty of tax fraud. Wavebreak Media/Thinkstock

In the U.S. no one goes to jail for owing taxes. You can go to jail for cheating on your taxes, but not because you owe some money and can't pay.

In fact,it would take a lot for the IRS to put you in jail for fraud. There is a very high burden of proof on the IRS when it comes to tax crimes serious enough to require prison time.

Furthermore, the IRS cannot simply take your bank account, your car or your house. Nor can the agency garnish your wages just because you owe money. The IRS must give you written notice and a chance to challenge what it claims you owe. As soon as you challenge, all collections must come to a halt, and if you take the revenue service to court you can have its hands tied for years.

If it's not that serious but you don't have the money to settle your debts with the IRS, you have several different options including paying in installments or changing your tax withholdings with your current employer [source: IRS].

3
Audits Are Always Done Immediately
A sign states the business hours in the James A. Farley post office in Manhattan, which is staying open until midnight on the last day to file taxes, April 15, 2014. Spencer Platt/Getty Images

Think again. The auditing process typically begins three to four months after the filing deadline.

Also, in most cases the IRS has up to three years to conduct an audit with the majority of them occurring in the latter two years. Simply put, it takes a while for the IRS to review millions of documents. If the IRS shows up after this point, you can quote the statute of limitation [source: Wood].

However, there are exceptions to this rule which we've listed below:

  • The three-year limitation is doubled to six if you omitted more than 25 percent of your income.
  • It's also doubled if you omitted more than $5,000 of foreign income.
  • The IRS has no time limit if you never file a return.
  • There's no time limit on fraud.
  • There's no time limit if you fail to claim foreign assets.

There are also some other complications. For example, your state may be running on its own clock on limitations. In California, for instance, the typical statute of limitations is four years [source: Wood].

2
Filing for Many Credits and Deductions Increases Your Audit Odds
Many people deduct clothing donations on their taxes; they need to be wary of not overestimating their value to lessen their chances of an audit. Tetra Images/Getty Images

If you've filed for several deductions or credits legally, then you should be fine. Credits and deductions are there for the purpose of relieving the burden of a hefty payment.

If you fraudulently filed for certain deductions or credits, such as the aforementioned earned income tax credit, that's when you run into problems. Especially since the IRS has caught on to the fact that millions of bogus claims for this credit exist.

Another typical problem taxpayers run into is overestimating charitable donations. It's common knowledge that you can deduct donations; however, what most people don't know is that they need to itemize the donations [source: IRS]. Additionally, overestimating the value of these charitable donations can lead to an audit.

The solution is to be as honest as possible when it comes to deductions and credits. Don't try and cheat the IRS and it won't audit you. And if agents show up, have the backup proof.

1
If I Got a Refund, I'm in the Clear
Go ahead: Put a down payment on your private plane with your tax refund. Just remember that getting the check doesn't mean you can never be audited for that return. Kiyoshi Takahase segundo/Hemera/Thinkstock

Sorry to burst your bubble, but this is completely false. If you've received a refund, all that means is that the IRS has agreed with your calculations. Getting a refund has absolutely no bearing on whether or not you will get audited later.

In fact, determining who gets audited happens months later. After your refund is paid, the IRS compares it to a model through a computer check. A computer program called the Discriminant Inventory Function System (DIF) assigns a numeric score to each return. If your score is high, then there's a good chance you may be audited [source:IRS].

Your return may also be selected for audit based off information sent to the IRS by third parties. For instance if the income you reported does not match the information on a 1099 or W-2 form, you have a higher chance of being audited [source:IRS].

And let's also remember the IRS has up to three years, and in some cases six years, to audit you.

These are just a few of the most common myths you'll hear about audits during the tax season. Moral of the story: Don't cheat the IRS, and you'll have nothing to worry about if you do happen to get audited.

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Author's Note: 10 Myths About IRS Tax Audits

As a freelance writer I've been running my own business for a few years now and am one of those lovely individuals who file a Schedule C. Rather than leaving it up to chance I went ahead and hired a credible accountant to help me with my books and taxes. Quite frankly, I've seen too many friends get audited because they used sketchy tax preparers, and I refuse to be one of them. Since tax law is always changing you may want to consider getting some help from a real professional. It is well worth the price tag.

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Sources

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  • Ellis, B. "How to survive a tax audit by the IRS." CNN. April 24, 2013 (Nov.13, 2014.) http://money.cnn.com/2013/04/24/pf/taxes/irs-audit/
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  • Internal Revenue Service. "Eight Tips for Deducting Charitable Contributions." March 22, 2011. (Nov. 13, 2014) http://www.irs.gov/uac/Eight-Tips-for-Deducting-Charitable-Contributions
  • Internal Revenue Service. "Ten Tips for Taxpayers Who Owe Money to the IRS." May 16, 2013. (Nov. 19, 2014) http://www.irs.gov/uac/Ten-Tips-for-Taxpayers-Who-Owe-Money-to-the-IRS
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  • Nitti, Tony. "What Are Your Odds of Being Audited by the IRS?" Forbes. March 25, 2013 (Nov. 13, 2014) http://www.forbes.com/sites/anthonynitti/2013/03/25/what-are-your-odds-of-being-audited-by-the-irs/
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