Taxes 2022: How to avoid an IRS audit of your taxes
Getting audited by the IRS is a common fear around tax time. So how nervous should you be? If you play by the rules and understand what can invite unwanted scrutiny, not very: The IRS conducts half the audits that it did just a decade ago. As of 2019, the agency was auditing only 0.4% of all taxpayer returns, down from more than 2% in the 1970s.
Still, it's important to understand what can raise red flags with the IRS, as well as how to be prepared in case the tax agency does audit you. While it's impossible to fully inoculate yourself give that portion of audits are truly random, tax experts say there are steps you can take to minimize the likelihood of receiving that feared notice from the IRS.
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"The IRS needs to make their own judgments about what resources they will put into auditing people and how much benefit will they get out of it," said Eric Bronnenkant, head of tax at Betterment. That includes "how much money can they collect from taxpayers who are doing something incorrectly, and how much does that instill the appropriate fear in people against doing the wrong thing."
A couple major issues can attract the IRS' attention, Bronnenkant noted. First, while the overall audit rate is low, there is a higher inspection rate for low-income workers who claim the federal Earned Income Tax Credit. Another major red flag is when people don't report all their income, which can happen if someone forgets they earned money from a side gig, for example.
EITC: Why the tax credit can lead to an audit
Some Americans may have more grounds for concern about getting audited than others. One such group is low-income households with less than $25,000 in annual earnings.
This group is five times as likely to be audited as everyone else, according to a recent analysis of IRS data by the Transactional Records Access Clearinghouse (TRAC) at Syracuse University. About 13 tax returns out of 1,000 filed by those earning less than $25,000 were audited in the fiscal year ended September 30, compared with a rate of 2.6 for every 1,000 returns for people with incomes above $25,000, the group found.
The reason is due to a higher rate of errors with the EITC, with one analysis finding that as many as half of returns claiming the tax credit had erroneously claimed too much or incorrectly claimed the credit, according to the conservative Heritage Foundation.
These audits are typically dealt with through letter, also known as a "correspondence audit." The IRS will send a letter to clarify an issue, as opposed to the typically more complex face-to-face audits. More than half of correspondence audits initiated by the IRS last year involved the EITC, TRAC found.
Report all your income
The IRS receives records from employers, banks, investment firms and other companies about your income. That means if the income on your tax return doesn't match its records, you could get flagged for an audit.
If you're not sure you know 100% of the income you made, you can check whether your information aligns with the IRS by requesting what's called a wage and income transcript. This reveals the information the IRS has on any type of income you received. You can request it going back 10 years.
"You're required to report income from whatever source you get it from, unless there's a specific exemption," said Martin Davidoff, national managing partner at accounting firm Prager Metis. "The highest volume of issues I see is failure to report income that gets reported to the IRS."
Don't round up — and avoid high write-offs
Another red flag for the IRS is when people estimate how much they've spent or received and round off the number, instead of reporting the exact amount. While "a certain amount of rounding is acceptable," writes Accounting Today, using the exact number is always your best bet.
High expenses for travel and entertainment on a business return are another such flag. The IRS "knows what the industry average may be," said Nina Olson, founder of the Taxpayer Rights Center and the former National Taxpayer Advocate. "And their formulas look at outliers."
What to do if you get audited
If you get audited, it will most likely be through a correspondence audit. The letter will tell you that you have been selected for an audit by the IRS and inform you about what information you'll have to send them, according to the Taxpayer Advocate Service (TAS).
Read the letter and send the information by the date the IRS requests it. If the agency needs more info, it'll reach out again, TAS said. While that seems simple, correspondence audits "can be challenging for low-income taxpayers," according to group's most recent annual report to Congress.
"Taxpayers wishing to speak with someone regarding an audit are limited to calling a representative on a toll-free line," the TAS report noted. "Getting through on the IRS's toll-free lines is difficult and time-consuming."
If you find the letter confusing, TAS recommends making an appointment at your local IRS Taxpayer Assistance Center or asking for assistance from a professional, such as a tax preparer. Taxpayers with incomes below $50,000 can also get help at a Low Income Taxpayer Clinic.
Be prepared to back yourself up by keeping your receipts and records, Betterment's Bronnenkant advised.
"If you don't have all the receipts and documentation for the expenses — say you are an Uber driver and didn't keep all of that — then the IRS may deny the deductions that you rightfully should claim but can't support," he said.
The IRS typically has a three-year time limit to audit your returns. In cases where you've substantially underpaid your taxes, the limit goes up to six years. Tax pros usually recommend you keep tax records for four years, to stay clear of the three-year limit.
— With reporting by Irina Ivanova
