Many believe that returns filed later in the season are less likely to be audited. That’s an urban legend.
All returns, whenever filed, are scanned for arithmetic errors and scored against top-secret internal algorithms. The higher the score, the more likely the audit. Random 1040’s are also pulled and are used to build the algorithms.
The algorithms appear to consist of a number of comparisons, at least in part. For instance, charitable contributions or itemized deductions are compared to income levels and a normal range is determined. When the IRS scans your return, it is looking for the degree of variance compared to their normal range. The more your return varies from the database “average”, the higher the score and the more likely the return is going to be audited.
The scans pick up missing income quickly and it seems that these are the first letters to go out. This is automatic. If you forget to include a 1099 or a w-2, you’ll get a letter which basically says we think you owe us some money.
Higher income will increase your chance of audit as well, as you might well expect. For instance, the IRS examined 0.5 percent of all individual returns for the 2017 tax year. The examination rate increased to 0.8 percent for non-business filers reporting $200,000 to $999,999 in income, and 4.4 percent for individual returns with $1 million or more in income.
Inflated business expenses are an IRS hot button. Businesses have a lot of wiggle room in reporting income and expenses. Some of the things that could trigger an audit include business losses, reporting items in round numbers, consistent business loss for a number of years, too high a business use of items that have both business and personal uses, such as cars or phones.
It should be noted here that the IRS has been criticized heavily in the last couple of years for not pursuing businesses that have claimed losses for many years, especially where there is high levels of other income that can absorb the losses resulting in reduced tax liability. For instance, a taxpayer in the 25% bracket shows a business loss of $5000. That can reduce a tax bill by $1250, not including any benefit in regards to state taxes. In the IRS view, the businesses are actually federally subsidized hobbies.
Another common audit item is wrongly claiming a child. This is especially common in shared custody cases. The custodial parent usually gets the exemption for children living in their home but often the divorced parents agree to trade back and forth each year. If you are a non-custodial parent claiming a child exemption, you should have a Form 8332 signed by the other parent granting you that exemption for that year or years. Without that, it usually boils down to who filed first. claims the exemption and the associated tax benefits.
Foreign accounts, such as bank or brokerage accounts can trigger audits. If your foreign assets exceed certain thresholds, you can be fined tens of thousands of dollars for failure to report such assets.
Of course there are many more reasons for audit, those described are just a few of the common ones.
Tax avoidance is perfectly legal. If you have a valid deduction, it should be claimed without fear. However, you do need to have the records to back up your claims. Without proof of the claims, your deduction will be tossed and you will be assessed interest and penalties back to the due date of the return being audited.
Because these audits often occur a year or more after the return is filed, the interest and penalties can really be a burden.
See AFS for help in responding to audits. You’d be surprised at how often the IRS is mistaken.
Aurora Financial Services – Use the Best for Less