Welcome to the first part of a three-part series on how to avoid an IRS audit. In this article, we will be introducing the general principles of the IRS audit system. In part two, we will explain what factors in your income may lead the IRS to subject your return to further scrutiny. In part three, we will be covering the factors in your credits and deductions which can cause an audit. Read on, and find out how and why the IRS moves your tax return to the top of the audit stack, and what you can do to avoid getting audited.
The horror, the horror: I’m being audited!
Summertime… and the living sure seems easy. You’ve fired up the grill. The dog has just relieved himself on your mother-in-law’s prized azaleas leaving you with feelings that strangely mingle distress and satisfaction. March and its bitter winds seem far away; tax season is long gone. And yet, here comes your spouse with the remains of yesterday’s mail, brandishing a shredded envelope high: something’s not right. Your hands, already damp from the heat of the coals, grow sweatier still as you take in the contents of the letter; the flies circle above your head like vultures. You’re being audited! The IRS has you in its sights!
Don’t panic!
First, don’t panic. And don’t toss the notice on the grill in a fit of pique; it’s hardly a suitable condiment for your burger in any case. Above all, don’t ignore it! The IRS audits just above one in every hundred individual returns every year: that’s a solid number, one that furthermore is going up as technological advances make the agency’s snoop and sort job easier, and as it hires more auditors to crawl over suspicious returns. Most audits address sins committed in the previous year, but some arc back to previous years. How many years back can the IRS audit your business? The correct answer is three. So it’s wise to keep your records in order for at least that long on the off-chance you get the dread call.
Not all audits are created equal.
Second, remember that not all audits are created equal. There are three types of audits. In the simplest instance of a correspondence audit, which applies to the majority, the filer receives a letter requesting additional information, often on a specific section of the return, which he can then forward to the IRS via mail by the requested date. Next in line, cranking up the level of complexity somewhat – and apprehension surely, is an office audit which surveys a wider swath of the return. In such a case, you would be required to visit an IRS office, paperwork in hand, and invited to go over the return to address its discrepancies. Last, but very far from least, roughly two percent of all audits undergo an actual field audit. This is a “Matrix” moment of sorts, when an audit officer, presumably suited if not dark spectacled, pays you a visit in your home or place of work and begins with something like… “Mr. Anderson” before proceeding to have the contents of your financial suitcase sniffed at like so much dirty laundry. Welcome to the desert of the real indeed.
How the IRS moves your return to the audit pile
Obviously, you want to do all you can to avoid getting to that sorry spot. But before we run through some of the triggers that alert the IRS to the potential need for an audit, and furnish you with some necessary tips to dodge an appointment with the man in the suit, it helps to have a cursory understanding of how the IRS evaluates a return for its, ahem, auditable content. The IRS computer geeks have come up with program that scans your return and assigns a score to it. This Discrimination Information Function (DIF) score is based on an algorithm that is as closely guarded as the secret recipe of your favorite cola. But if we have no way of knowing exactly how the numbers are crunched it stands to reason which are. The IRS surveys your income, the deductions you’re taking, what credits you’re claiming, and relates them both to each other and to outside factors such as your place of residence, the size of your family, and your profession. Your deductions, for instance, are compared to those of others in your income bracket and, bluntly put, if they appear excessive relative to your income, your return is issued a high DIF score and gets slotted for potential review by an actual humanoid trained to smell a rat.
What did I get wrong?
If you used the service of a qualified tax preparer, you’re probably juggling some choice insult as you watch the embers glow and the meat char on that otherwise fine summer day. Eventually, you’ll coax your memory into remembering their number and call them to sort out the mess. But if you did your own taxes you’re surely wondering, well, where did I go wrong. Recall the three main prongs that underpin the DIF formula: income, credits, and deductions. It’s likely you got one or more of these wrong: you may have under-reported your income, perhaps omitting to include the amount from that 1099 you accidentally misplaced; you took deductions that were not allowed, thinking they were legit when they in fact qualified as bogus; you claimed a credit which you had no right to. Any, or all of these, popped up red flags, discrepancies that were picked up by the IRS sensors. We’ll address each category separately and in depth, in the following installments of this series.
