2014 IRS Audit Report
The fear of an audit is a driving force deeply engrained in the psyche of the American taxpayer. In fact, it’s the third biggest reason why people pay their taxes and do so honestly, according to the Internal Revenue Service, ranking only behind personal integrity and the fact that third parties already report certain income information to the feds. But is our fear ultimately warranted?
You’re far more likely to get audited than you are to win the lottery, get struck by lightning or be attacked by a shark – that’s for sure. But still, only 1% of individual taxpayers were audited in 2013, according to IRS data, which means the hype probably exceeds the actual risk when all is said and done. That would seem to be especially true this year, as recent budget cuts and the October 2013 government shutdown have seriously cramped Uncle Sam’s enforcement style.
Nevertheless, it’s unwise to take scarce IRS resources as an excuse to misreport and hope that you won’t be caught. It’s simply not right, and definitely not a risk worth taking. Just think about what happened to Al Capone, Willy Nelson, Wesley Snipes, Lauryn Hill and all of the other famous tax evaders. Sure, their celebrity likely resulted in increased IRS scrutiny, but as you’ll see below the IRS will ultimately catch up with you regardless of your social status.
WalletHub analyzed historical IRS data in order to determine how audit rates compare across tax brackets as well as between individuals, small businesses and large corporations. We also looked at historical audit results as well as incarceration statistics and even how the IRS enforcement division has changed throughout the years. You can find a complete breakdown of our findings below.
- For both consumers and corporations, the smaller the income, the higher the rate of tax evasion.
- Audited consumers who make less than $200K pay 83% higher penalties (as a percentage of adjusted gross income) than people making more than $200K.
- Audited corporations that earn $250K - $1M pay more than 11-times higher penalties (as a percentage of adjusted gross income) than corporations earning $10M - $50M.
- Individual taxpayers have a 1% chance of being audited. The individual audit rate has fallen more than 9% since 2010.
- Small businesses have a 1% chance of being audited. The small business audit rate has increased more than 17% since 2009.
- Large corporations have a 15.80% chance of being audited. The large corporation audit rate has increased 8.6% since 2009.
- Individuals making $10 million or more are 3,933% more likely to be audited than those who make $25,000 - $100,000.
- Corporations with more than $20 billion in annual revenue are 11,300% more likely to be audited than companies with less than $250,000 in revenue.
- 11% of individual audits result in no additional tax obligation, compared to 28% of small business audits and 27% of large corporation audits.
- The number of IRS agents dedicated to Examinations, Collections and Investigations has declined more than 12% since 2010.
- The annual number of incarcerations for tax crimes has increased more than 117% since 2003.
Audit Rates by Type of Taxpayer
Individual Audit Rates by Income Bracket
Corporate Audit Rates by Annual Revenue
Recommended Post-Audit Payment, As a Percentage of AGI (Individuals)
Recommended Post-Audit Payment, As a Percentage of Annual Revenue (Corporations)
Percentage of Returns Examined with No Change
Percentage of Audits Where There is Disagreement About Additional Tax Obligation
Number of Civil Penalties Assessed
Number of Incarcerations for Tax Crimes (2000 – 2013)
Mistakes & Enforcement Staff
Number of IRS Employees Dedicated to Examinations, Collections & Investigations
Most Common Taxpayer Math Mistakes, As a Percentage of Total Math Mistakes
- What are the best ways to avoid an audit?
- What are the best ways to handle being audited?
Due to budget cuts and reduced staffing at the IRS, slightly less than 1% of individual taxpayers are likely to be selected for an audit.
In the event that you are part of that unlucky one percent, the possible reasons why you were selected include, in addition to errors on your return, are: (1) random selection and computer screening - sometimes returns are selected based solely on a statistical formula; (2) document matching - when payor records, such as Forms W-2 or Form 1099, don't match the information reported, and (3) related examinations - returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.
1. Have your return prepared at a VITA site or use commercial tax preparation software.
2. Follow the instructions from the VITA folks or the software
3. Do not think of your tax return as a first offer to the government
Unfortunately, I take a very old fashioned view of the tax filing obligations!
Returns are generally selected for audit if there is something out of the ordinary on the return. For example, a return will attract scrutiny if third-party income that has already been reported to the IRS by the payor is not reflected on the recipient’s return. If there are numerous math errors on the return, or if the return is missing forms and schedules, the IRS is likely to look more closely. If the deductions that are taken on the return fall outside of statistically normal ranges, a return is likely to attract the attention of the IRS. Returns of self-employed individuals are audited more frequently than returns filed by persons who are employed by others.
#1 - Live in a district or state represented in Congress by a member serving on a committee overseeing the IRS and call them if the IRS is abusive. #2 - Be careful in claiming earned income tax credits, deductions for charitable contributions, both in cash and in kind, and reporting losses from self employment (Schedule C); set up an S-Corp or LLC and hire a good (aggressive) tax preparer.
What are the best ways to handle being audited?
Keep accurate records and don't lie - if questioned, say that you ‘forgot’ to report some of your income (many income payers don't issue 1099s). See #1 above.
One of the best ways to avoid an audit is to double check all figures and calculations on your tax return. This advice is extremely simple, but it is incredibly important when trying to stay on the good side of the IRS. Many individuals will wait to the last minute when completing their tax return, especially when they believe they have a tax balance due, and they do not give themselves an appropriate amount of time to review their tax return before submitting to the appropriate taxing authority. You should always review your tax return for errors before filing, and I always believe it can be a good idea to set aside your tax return and come back to it later to double check all inputs and calculations.
Outside of this simple advice, tax filers should also beware of the following when trying to avoid an audit:
• Do not report income figures that are lower than actual wages and/or income.
• Do not inflate self-employment and related deductions.
• Do not take tax credits in which you are not qualified and/or do not have appropriate documentation.
• Do not inflate itemized deductions and/or take itemized deductions to which you are not qualified.
What are the best ways to handle being audited?
While no one enjoys being audited (or even the idea of being audited), there are ways to survive an audit. The best advice I can give to any tax filer who is dealing with an audit is to answer tax authority inquiries within the appropriate time frame as requested by the taxing authority. Many tax filers will just file away requests by taxing authorities for documentation hoping that the issue will go away over time or the taxing authority will forget about the request. Many times not answering a request for further information or providing documentation on a tax item will be a signal to the taxing authority that their assessment is correct, while this may not be the case. Know your rights when it comes to an audit and consult a tax professional if you do not understand the taxing authorities request for information. Never make assumptions when it comes to tax and understand the details when it comes to your personal situation.
Avoid an audit by being careful in preparing the return and avoiding the obvious areas of abuse: home office deductions that are not reasonable and clearly justified, other business expenses that are not reasonable and clearly justified, etc. Also make sure to report ALL income accurately if you do any independent consulting, have investment income or income from the sale of tangibles etc. If a client/customer of yours sends in a 1099 and you don;t report the income, that is an obvious red flag.
What are the best ways to handle being audited?
If you get audited, review your return for mistakes and try to estimate the amount of your tax exposure (debatable deductions, unreported income, etc.). If you made mistakes, acknowledge them up front to build trust with the IRS auditor. If you believe you have substantial exposure to penalties and particularly if you have exposure to criminal prosecution for tax evasion or a similar offense, contact a lawyer as soon as possible and BEFORE you say anything to the IRS.
Most IRS examinations are conducted by correspondence. Most of the correspondence examinations are based on tax information IRS has obtained from employers (W-2s), banks (forms 1099-INT (Interest Income), Brokerage statements, etc. If items on your tax return do not match-up or agree with the documents sent directly to IRS, you'll get an IRS Notice correcting the situation. That's not to say all IRS Notices, where IRS proposes to change the tax due, are correct! In any event, to avoid tax audits, report all the information contained on tax documents such as W-2s, 1099s, etc. on your tax return.
Also, make sure dollar amounts on these various tax documents agree with the amounts that end up on the tax returns. Tax return preparers do make mistakes entering data into tax preparation software. To avoid an audit, make sure your tax document amounts agree with amounts on your tax returns.
IRS Notices requesting verification of items or additional documentation, can easily be addressed by most taxpayers. However, make sure you only respond to items being question by IRS in the Notice.
In more complicated scenarios, taxpayers should consider hiring a seasoned tax practitioner to hand an IRS examination. Whether the audit is a face-to-face meeting or a response to an IRS Notice, practitioners generally can guide the audit process in a manner that is beneficial to the taxpayer's interest.
Sources: The information used to construct this report is courtesy of the Internal Revenue Service, the U.S. Bureau of Labor Statistics and news reports.