Being Audited? What are the Chances?

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Good question. On average you have less than a one percent chance, as an individual, of being audited by the IRS. Don’t get complacent though, that figure is only part of the story. Only when you crunch the numbers does a more nuanced picture emerge regarding your chances of being audited.

First, you have to understand that the IRS does not do audits at random. The IRS does not consult tea leaves or throw darts against a list of taxpayers to select a return for audit. Instead the IRS uses two major methods of choosing individuals for audit: information provided by third-parties and by use of a computer algorithm.

Information provided by third-parties is easy enough to explain, if the IRS learns that a taxpayer may be hiding income or taking excessive deductions then it may select the return for audit. The classic example is an ex-spouse informing on his or her former partner but it can also include an audit triggered by information provided by banks or other financial institutions. For example, banks are required to report cash transactions exceeding $10,000 which may indicate potential tax evasion.

The other and far more prevalent method of identifying returns for audit is the use of various, and undisclosed, algorithms. The IRS is very tight lipped about what goes into its software but it has said that these algorithms use data gathered during audits and from other sources to develop a norm against which a taxpayer’s return is compared. The taxpayer’s return is scored based on how it deviates from the norm; the higher the score, the greater the chance of being audited. The algorithm also is weighted to increase the rate of audits where the IRS perceives certain types of returns have a higher potential for abuse or for positive audit adjustments. As you will see below, taxpayers who claim the earned income tax credit have an increased chance of being audited which is a response to a recent flood of fraudulent returns claiming the credit.

Regardless of the method of selecting a return for audit, once a return is selected an examiner will review the return to determine if there are grounds to  hand the return off to an IRS agent to be audited. The IRS only wants to audit returns where there is the potential to recover money for the Treasury; the IRS does not want to waste valuable time and money handling low-return audits, it would rather concentrate on audits that will justify its efforts.

Here are some stats from the IRS’ latest report, based on tax returns examined during 2015:

  • Overall, taxpayers face a 0.8% chance of being audited.
  • This rate increases if the tax return includes the earned income tax credit, up to 1.7% for those tax returns with gross receipts of less than $25,000; this decreases to 1.0% if gross receipts are $25,000 or more.
  • Tax returns that have total positive income under $200,000 and which do not include any income from operating a business and which do not claim the earned income tax credit have a 0.3% chance of being audited.
  • Tax returns that have total positive income under $200,000 and which include income from operating a business and which do not claim the earned income tax credit have between 0.3% and 2.0% chance of being audited, depending on the type of business and total gross receipts from the business. The breakdown is:
    • 0.3% for tax returns which include a Sch. F (farming activity)
    • 0.9% for tax returns which include a Sch C with gross receipts less than $25,000
    • 2.4% for tax returns which include a Sch C with gross receipts of at least $25,000 but less than $100,000
    • 2.5% for tax returns which include a Sch C with gross receipts of at least $100,000 but less than $200,000
    • 2% for tax returns which include a Sch C with gross receipts of $200,000 or more
  • Tax returns with a total positive income over $200,000 but less than $1,000,000 have a 1.8% of being audited, which increases to 2.9% chance if the return includes income from operating a business.
  • Tax returns with total positive income $1,000,000 and up have a 9.6% chance of being audited

Note: total positive income is the sum of all positive amounts shown for the various sources of income reported on the individual income tax return and thus, excludes losses.

As you can see, depending on your taxpayer profile, for lack of a better term, you may have a higher risk of audit than the average would lead you to believe. This doesn’t take into account your particular return which may deviate further from the norm than other returns in your category which can make it even more likely your return is audited. Like the old G.I. Joe cartoon always said, now you know and knowing is half of the battle.

You can read the full report here: 2015 IRS Data Book. There is a great deal of other interesting information on this report and it is worth perusing.

Image courtesy of 401kcalculator.org

 

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