The odds are in your favor that you won’t get audited by the IRS, but don’t get cocky and cheat. The agency has tools at its disposal to catch errors and outright tax scofflaws.
Audits were down almost 16 percent in 2016 compared to the previous year. Just over 1 million individual income tax returns received the extra scrutiny last year, the lowest number since 2004, according to the IRS.
I asked some members of the California Society of Certified Public Accountants about the impact of the decrease in audits. Here are things that they said could increase the chances that your return will be audited:
• Being a millionaire or self-employed. “The IRS makes a cost/benefit decision in regards to audits,” said CPA Mitchell Freedman. “So, they follow the money. If you make over $1 million per year, there’s a pretty good chance you will be audited. If you make more than $200,000 per year, you have close to a 2 percent chance of being audited.”
If you report any business or self-employment income on a Schedule C, you are more likely to be audited than a salaried individual, Freedman said. “Why is that? Because a salaried person generally has few if any expenses to deduct against her income, whereas a self-employed individual can claim a great many expenses deducted against his gross income.”
• Failing to report all your income. “While audits in general have declined over time, additional reporting by various areas of the financial world have allowed for more matching of documents,” points out Janet Lee Krochman, a CPA from Costa Mesa, California.
For example, the IRS has the ability to compare what your ex-spouse paid (and deducted) in alimony to what you reported as income from alimony, said CPA Andrew Porter.
• Forgetting that others are sending the IRS information about your tax situation. The IRS has several different types of audits. The most basic is called “automated underreporter,” or “AUR.” This type of audit is done completely by computer, according to CPA Mary Kay Foss. The IRS computer compares the 1099s (freelance income), W-2s (wages) and 1098s (mortgage interest) it receives with the returns. “Anyone with many sources of income that are reported on those tax forms is a likely target,” Foss said.
She added that if you receive an IRS form CP2000 letter generated by an AUR, respond right away because it could be an error.
“Often, taxpayers are afraid to open envelopes from the IRS because of their fear, and as a result, sometimes deadlines are missed or taxes are assessed unnecessarily,” Foss said. “Hopefully knowing that audits are down, taxpayers will be less reluctant to open the envelopes.”
Correspondence audits generally target taxpayers who claim large mortgage-interest deductions or charitable contributions, Foss said.
If you’re a taxpayer with a pricy home, be sure you report the correct amount of mortgage interest. “The IRS has been receiving mortgage loan balances in an effort to ensure that taxpayers are properly reporting,” said Gregg R. Wind, a CPA in Los Angeles.
Wind warned that a big mistake on your taxes, such as substantially understating your income, could result in a pretty severe penalty. The IRS has the authority to hit you with an accuracy-related penalty equal to 20 percent of your underpayment of taxes.
• Showing a pattern of losses for your small business. In such cases, the IRS wants to make sure that yours is a viable business and not an excuse to deduct expenses in connection with a hobby, Foss said.
• Claiming deductions that are especially out of line for people with similar income. The IRS looks for cheaters who inflate deductions, such as the value of goods donated to charities, the amount of unreimbursed business expenses, cash contributions and medical expenses, Foss said.
“Better be good for goodness’ sake, regardless of the odds of the IRS coming to town,” said Jean-Luc Bourdon, a CPA from Santa Barbara. “Claim every legitimate deduction you are entitled to, regardless of audit odds. Simply be ready to prove that what you claim meets all the requirements.”
Still, there are folks who will tempt fate.
“The IRS matching system does a good job of deterring people from not reporting income,” said Cari Weston, director of tax practice and ethics for the American Institute of CPAs. “However, our complex tax system creates many more avenues for abuse,”
Don’t risk an audit. My motto is: Never mess with the IRS.
Michelle Singletary can be contacted at:
michelle.singletary@washpost.com
Twitter: SingletaryM
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