"The IRS' mission is to get people to voluntarily comply with the tax code -- and to encourage that, you've got to get your audit numbers up," said Gary Iskowitz, a Los Angeles Certified Public Accountant who once served as the head of the IRS's examination division in Baltimore.
Audits jumped 11% in the most recent fiscal year, the agency announced this week. The chance of an audit is still only about one in one-hundred -- 1.04% of taxpayers faced audits in 2010. But the odds of an audit soar if you're high income.
Roughly three in every 100 individuals reporting income of $200,000 or more were audited last year, while 8.36% of those with income above $1 million grappled with an audit. Notably, while audits rose in all categories, audits of millionaires rose by more than 30%.
The reason tax experts believe more audits are coming? The agency has also boosted its audit staff by 8% overall and has vastly improved "data matching" programs that pick up information about income you might have failed to report on your return. More examiners will be hired next year, too, if the IRS is able to convince Congress to appropriate enough money to the agency's budget.
The agency can argue that adding staff has a huge payoff -- a compelling selling point during these years of record-setting budget deficits, too. Revenue from examinations and appeals soared 34% and 46% in 2010, respectively.
If you're audited...
That said, if you're an honest taxpayer who attempted to file an accurate return, you shouldn't assume that you're in trouble if the IRS examines your return. The IRS makes plenty of errors, said Phil Holthouse, partner in the Los Angeles tax law and accounting firm of Holthouse Carlin & Van Trigt. In some cases, they'll tell you that you failed to report income, but you simply included the income on another line of your return.
"Don't assume that they're infallible," Holthouse said. "Go back and check your return."
If you agree -- you realize that you missed something or made a mistake, simply send back a note and a check. Your audit is solved.
If you disagree, you should first dispute the item with a letter and send it via certified mail, with a return receipt. That ensures that the IRS can't claim to not have received your dispute, said Iskowitz.
If the IRS disagrees with your disagreement, they'll send another letter that essentially tells you to pay up or take the matter to tax court, Iskowitz said. But there's a third option, that he says is better: Ask to have your case sent to appeals.
The IRS' appeals division is staffed by senior agents, who can independently look at your tax dispute and make a determination about whether it's worth pursuing. A large number of cases can be decided at this level, without going through the formality of tax court.
If you must go to tax court -- or if you know that you played fast-and-loose with the facts -- do not attempt to solve your tax problem on your own, Iskowitz says. Give your CPA power of attorney and have him or her represent you. There are two reasons why this is particularly important, he adds. First, the CPA is more likely to understand the questions that are being asked than you are -- and understand the implications of those questions and the IRS response. If an audit is abruptly ended, for example, you might think you're home free. In reality, that's a sign that your file is about to be turned over to criminal investigations.