Chance of being audited is greater than you think

What's your chance of being audited? If you've read IRS statistics, you might think the chance is minuscule -- about one in 100. Dive deeper into the agency's enforcement report, and you'd think that the chance of a middle-income person like you -- someone earning between $25,000 and $100,000 -- being subject to an audit would be far more rare, hitting just six or seven taxpayers in 1,000. But a top government official maintains that those statistics, while accurate, are misleading -- reflecting only interactions that IRS defines as formal audits.

In reality, your chance of getting "touched" by the IRS in a way that feels like an audit -- but (disturbingly) provides few of the taxpayer protections of an audit -- is many times greater, says Nina Olson, who serves as the nation's Taxpayer Advocate, a federal position aimed at helping taxpayers solve their problems with the IRS.

Just 1.4 million taxpayers are subject to what the Internal Revenue Service considers "real" audits each year, but more than 9.2 million additional taxpayers are targeted by what Olson calls "unreal" audits in which the IRS sends official -- and often frightening -- notices demanding more money. Almost 7% of low- and middle-income taxpayers received one of these notices last year, she says.

In 2010, these unofficial audits resulted in:

  • 3.9 million taxpayers receiving "under-reporter" notices -- an official letter from the IRS saying that you've failed to report income and are being assessed tax and penalties on the unreported amount.
  • 4.7 million math-error notices that demanded additional tax. (Some 4.6 million Americans also got notices that said they erred in the IRS's favor and were eligible for bigger refund checks. These are not counted in Olsen's statistics because she's solely looking for the type of IRS letter that would have the same negative and potentially frightening impact as an official audit notice.)
  • 563,927 individuals, who did not file returns, received "ASFRs" - a substitute tax return prepared by the IRS based on third-party information.

These unofficial audits are triggered by the massive and growing electronic income-matching program, which requires that banks, brokers and many other vendors tell the IRS how much they paid to whom. The IRS matches the Social Security numbers on tax returns with the information provided by these third parties. When there's a mismatch, the agency sends out letters and, sometimes, withholds refunds. The presumption is that the taxpayer erred. The taxpayer is charged with proving otherwise.

Worse, government rules aimed at barring "unnecessary examinations" make it clear that you cannot face two audits for the same issue and tax year. But that only applies to official IRS examinations. The vast number of unofficial audits are not covered by the rule, says Olson. That means you could respond to the IRS, providing enough information to resolve your unofficial audit, only to turn around and face an official audit on the same topic in the same year.

"From the taxpayers perspective, being contacted by the IRS more than once about one year's return can feel like, well, at least one time too many," Olson says.

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