After reading this headline, you might not expect this story to lead off with a good-news/bad-news scenario, but here goes:
The good news is that the IRS conducts “real” audits (also known as formal audits) on only about 1.4 million taxpayers a year – or about 1 percent of those who file individual returns. And if you earn less than $100,000 a year, it is much less likely that you’ll be one of those unlucky 1.4 million folks.
The bad news is that getting audited is only slightly more pleasurable than having thousands of leeches suck all of the blood out of you. And the IRS has stepped up the number of audits it is conducting, particularly on the very wealthy. If you earn $500,000 to $1 million, you have about a 6 percent chance of being audited, compared with 3.4 percent as recently as in 2010, and if you make between $1 million and $5 million, the chance that you will be audited rises to 12 percent, considerably more than the 6.7 percent in 2010.
Of course, you have no control over whether the IRS chooses to audit your return, but it is helpful to know what the IRS considers red flags. Here are a few of the most common ones:
- Large charitable deductions
- Large business expenses
- Inaccuracies on filed returns
- Excessive itemized deductions
- Prior tax problems or audits; and
- Complex business or investment transactions
For more information on audit red flags, see 5 Tips To Avoid An IRS Tax Audit.
If you consider yourself a glass-half-empty person and assume you will be audited eventually, do a good job of compiling records that will help you if the IRS comes calling. These records include:
- At least three years worth of tax returns and documents
- Checkbook stubs
- Receipts from all purchases throughout the year
- Cost basis documents for property and taxable investments
- All bills, which you should organize in folders; and
- Deductible items, such as charitable contribution receipts and letters.
If you do get audited, here are some things you should do:
The IRS has compiled a list of 10 tips for those who have been audited and six of them start out with “Be prepared to…” The first step in being prepared is to have a thorough understanding of your tax return. This is easier said than done if you have a complicated return that was submitted by an accountant. The next step is to organize your records so you will be in a better position to answer questions posed by the IRS.
Some people can go it alone. For others, it makes sense to have someone on your side. The IRS has something called the Taxpayer Advocate Service, formerly known as the Problems Resolution Office, which was created to help people and the service is free and, of course, confidential. You can find your local advocate on the IRS website or by calling 877-777-4778. If it feels weird getting help from someone approved by the IRS and you can afford it, consider hiring a certified public accountant or a tax attorney who has experience in these matters.
Whether or not you have help, establish a range of settlements that you are comfortable accepting. This will prepare you for possible settlement terms that might be discussed later by the IRS examiner.
Do Not Volunteer Additional Information
A lot of honest people want to appear to be open books. They have nothing to hide, but – whether you have a correspondence audit or an office audit -- it is a bad idea to give the IRS more information than it requests. That may open you up to a new investigation. If the IRS examiner asks you for information not mentioned in its notice, politely decline to respond unless the agency files a formal request for it. In a related matter, if the audit is related to your business, remind all employees that they should not give any information to an IRS examiner. All inquiries should be directed to you.
About 10 days before your meeting with the IRS examiner, give the IRS written notice that you will make an audio recording of the meeting. (Video recordings are not allowed.) This recording may help you later and you will want to do it especially if you don’t have an accountant or lawyer with you.
You have a right to appeal an IRS decision with which you disagree. You have 30 days to file the appeal through an IRS appeals office, though it could take a year or more before your appeal is heard. According to the IRS, taxpayers who appeal receive a ruling that is more favorable to them about 64 percent of the time.
So the moral of this story is pray that you don’t get audited, but if you are, prepare yourself as if you are going into battle, because you are.