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.
The Auditing Process Is Always a Nightmare
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 74.6 percent being conducted that way in 2018 [source: IRS]. 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.
Audits Always Mean You Have to Pay More Money
In the IRS publication "Taxpayer Bill of Rights" 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 [source: LII].
It's a Common Occurrence
Audits don't happen as often as one would think. In fact, according to IRS examination statistics, the agency only audited 1.0 million returns filed in 2017. While that may seem like a lot, it's really only 0.59 percent of the 196 million returns filed the previous year [source: IRS].
- 2.04 percent of the people who had no adjusted gross income were audited.
- 0.69 percent of those who earned less than $25,000 were audited.
- 0.48 of the people who earned between $25,000 and $50,000 were audited.
- 0.54 percent of the people who earned between $50,000 and $75,000 were audited.
- 0.45 percent of the people who earned between $75,000 and $100,000 were audited.
- 0.44 percent of the people who earned between $100,000 and $200,000 were audited.
- 0.53 percent of the people who earned more than $200,000 but less than $500,000 were audited
- 1.1 percent of people who between $500,000 and $1,000,000 were audited.
- 2.21 percent of people who earned between $1,000,000 and $5,000,000 were audited.
- 4.21 percent of people who earned between $5,000,000 and $10,000,000 were audited.
- 6.66 percent of the people who earned more than $10,000,000 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 20 percent between 2010 and 2018 [source: CBO]. 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].
You Have to Make Big Money to Be Audited
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.
In reality, who make between $25,000 and $500,000 generally are audited at roughly the same rate, around one-half of one percent of all returns [source: IRS].
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 $6,660 in 2020 if you have three or more children and an income of up to $50,594 for a single parent and up to $56,844 for married couple filing jointly [source: IRS]
If You Use an Accountant, You Won't Be Audited
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 possesses.
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.
Self-employed People Get Audited More
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 low. Even filers with incomes $200,000 and $1 million only had a 1.4 percent audit rate [source: Taylor].
The IRS Will Take Everything and Put Me in Jail
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].
Audits Are Always Done Immediately
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 after a return was filed or is due, whichever is later, to conduct an audit [source: IRS] Simply put, it takes a while for the IRS to review millions of documents.
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].
Filing for Many Credits and Deductions Increases Your Audit Odds
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.
If I Got a Refund, I'm in the Clear
You might assume that because the IRS accepted your return and paid a refund, that means you are in the clear. But that's not necessarily the case. While the IRS says that it tries to audit tax returns as soon as possible after they are filed, in practice, the volume of returns that it has to manage means that it can take a while to get around to them. "Most audits will be of returns filed with the last two years," the IRS explains on its website [source: IRS].
Returns sometimes are flagged for audits by a computerized system that looks for numbers that are outside the statistical norms for similar returns. Additionally, the IRS sometimes selects returns for audits because they involve issues or transactions with business partners or investors who've already been picked out for scrutiny [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].
If your return is pulled, an experienced auditor will take a closer look at it. In some cases, that person eventually may opt to accept the return. But if the auditor spots something that looks questionable, he or she will identify the items and forward it to an examining group for a fuller audit [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.
Last editorial update on Feb 27, 2020 05:33:33 pm.
Many Americans don't think about their tax bills until the new year. But there are things you need to do before Dec. 31 if you want to pay less later.
Author's Note: 10 Myths About IRS Tax Audits
Since tax law is always changing, , you may want to consider getting some help from a tax professional. It is well worth the price tag.
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