Tax audits explained (not as scary as you think)

In movies, tax audits are always scary. Big, burly, intimidating men in dark suits and glasses. Oversized clipboard. The sound of pens furiously scraping across paper. Wives. You know the deal.

But are tax audit visits really that scary in real life? Not so. In fact, less than 1% of all taxpayers even experience an audit. Of those, approximately 15% result in a face-to-face encounter with the IRS. Most queriesFortunately, they are resolved through postal correspondence. Take a look below at our guide to tax audits.

Audits explained

Although audits have increased slightly in recent years, the chances of being audited are still low. For all returns filed for tax years 2011 through 2019, the IRS has examined 0.55 percent of individual returns filed. Most audits are done by mail. Last year, 85% dealt with the IRS by correspondence, while fifteen% came for an in-person exam. IRS reports that correspondence audits are cheaper in terms of the direct cost to the IRS and the taxpayer burden. According to Georgetown professor Thomas Cooke, people tend to take action as soon as they receive a letter (perhaps hoping to delay any personal visits). However, he doesn’t assume the IRS is correct. Investigate the issue the IRS is challenging. In many cases, the IRS may not be able to compare the information reported to them with what you reported. Fortunately, it can be something as simple as providing additional information or an explanation to meet your requirements.

Mail audits usually require you to provide information (or evidence) about very specific claims made on your tax report, or a check for unpaid taxes. On the other hand, an “office audit” is a bit more complicated and more intimidating: You’ll have to go to an IRS office. A third option, a “field audit,” is usually a more comprehensive examination and takes place at the home or business office where you work.

The IRS will let you know what documents are needed in advance. If your documents support the original statement, you shouldn’t have a problem: the audit is “no change.” If the auditor finds a discrepancy (and you agree), you can sign the documents and pay any taxes due. You can choose not to agree with the auditor’s findings, in which case you can appeal the decision later. As a general rule, it is best not to offer the IRS agent any information beyond what is specifically needed. Failure to do so could lead to additional questions from the IRS.

You could be audited if…

You claim losses. If you are a business owner, you will first need to prove that your business is legitimate (meaning your intent is to make a profit) and not a hobby. Claiming a loss of $5,000 to $10,000 is usually a red flag; If you are audited, you will need to provide statements related to loans, business bank accounts, business licenses, and income.

Claiming rental losses can also be a red flag for the IRS, since you can typically only deduct a limited amount of losses, and you still have to meet certain conditions. If the “passive” loss allowance is more than $25,000, wait for a notice from the IRS.

You claim unusual deductions. If your deductions are unusually large, your chances of being audited are much higher than average. This is because, historically, some taxpayers have attempted to deduct non-business expenses (such as home phone service, living room or bedroom space, etc.) for tax purposes. The same goes for extravagant business deductions related to dining or entertainment.

charitable contributions. Claim a large charitable deduction and chances are you’ll be on the IRS’s hot list. This is because, in the past, the documentation requirements for charitable contributions were less stringent than they are today.

you have a cash business. The IRS knows that businesses that deal a lot with cash transactions, like taxi driving, beauty salons, etc., can easily hide income. The IRS has created a new cash-intensive business guide for agents, so be careful with your documentation and reporting.

If you have evidence of your claims for all taxes, you should be fine.