One of the first images that come to mind when I think about taxes is one of those old TV sitcoms where the dad is drowning in paperwork. He is frantically attempting to do his taxes by April 15 as seen by the calculators scattered around the table and countless trails of paper tape. Thanks to tax filing software, accountants, and computer files, this situation is no longer a reality. Therefore, even if it's not exactly the most enjoyable task, filing taxes isn't nearly as onerous as it formerly was. Tax audits, on the other hand, are one aspect of the tax procedure that still causes many people to wake up in the middle of the night in a cold sweat.
Bring up the images of auditors putting handcuffs on you and escorting you to jail. That's unlikely to occur in reality. The United States does not have any debtors' prisons. But what might occur to you? And how does the IRS decide which people to pursue? The IRS's lack of transparency regarding its tax auditing procedure doesn't help. Is it fair to blame the agency? Why would it divulge the game plan? The good news is that information is more readily available than ever. To help you relax about the possibility of being audited, we'll differentiate fact from fiction over the course of the next ten pages. Starting with the most blatant myth.
The auditing procedure is very difficult
Not always true. In most cases it's not even remotely true. The first thing you have to understand is that there are different kinds of audits. A mail audit is simply the IRS trying to verify a specific line item, and it involves you mailing in all of the support documents for that particular figure. If you can prove the number is correct, then it should lead to a quick and hassle-free conclusion. Mail correspondence is the most common form of auditing these days, with 74.6 percent being conducted that way in 2018 [source: IRS]. The other form is an in-person audit where an IRS agent will request an appointment with you to provide certain financial information. Nevertheless, a lot depends on you as to whether the auditing procedure is a nightmare or not. It will be far less stressful if you have your financial records organized than if you don't know where anything is.
Audits Almost Always Result in Higher Costs
Taxpayers have the right to only pay what is legally required and to have all tax payments applied correctly by the IRS, as stated specifically in the IRS book "Taxpayer Bill of Rights." They are not pursuing you because you owe them more money than they are. According to South Florida-based accountant Eric J. Nisall, who focuses on assisting independent contractors and small businesses, the IRS occasionally discovers deductions that were overlooked but could have been claimed. If you are unsure whether the Internal Revenue Service Restructure and Reform Act, sometimes known as the "Taxpayer Bill of Rights," which Congress passed in 1998 to ensure the IRS treated taxpayers equally, is the answer to your question, it is enforced. One of its numerous restrictions prohibits the IRS from taking someone's home to cover a debt of $5,000 or less.
It Frequently Occurs
The frequency of audits is lower than one might imagine. In actuality, the IRS only examined 1.0 million of the tax returns submitted in 2017, according to examination statistics. Even though it might seem like a lot, that is just 0.59 percent of the 196 million returns that were submitted the year before. Therefore, audits are not at all frequent. Some predict that as the agency continues to lose budget and consequently workers, they will occur even less frequently. Between 2010 and 2018, the IRS's budget was cut by 20%. Because of this, it is more challenging for the IRS to manage its workload and audit as many people as it would like to.
To be audited, You Need to Make a Lot of Money
While it may be true that large corporations and people with high salaries are frequently the subject of IRS investigations, this does not necessarily suggest that those in the low- or middle-income range won't be subject to an audit. In actuality, people who earn between $25,000 and $500,000 typically have their returns audited at a rate of about 0.5 percent of all returns. The IRS has also been taking action against taxpayers who falsely claim the earned income tax credit, which is a significant tax break worth an average of up to $6,660 in 2020 if you have three or more children and an income of up to $50,594 for a single parent and up to $56,844 for a married couple filing jointly.
You Won't Be Audited if You Use an Accountant
The selection procedure for audit has nothing to do with how you prepare your taxes—whether you hire an accountant, a tax attorney, an enrolled agent, or just use your own initiative. There is no space on the return to state the qualifications of the preparer, and audits are typically chosen by computer software. The IRS protects the audit selection methodology, but we do know that it's based on a few things, such comparing your charitable tax deductions to someone with the same salary. Filing a Schedule C profit or loss from a business or an E profit or loss from royalties, S corporations, or rental real estate is another cautionary sign. People that submit them have a higher likelihood of being audited.
People who are self-employed are audited more
Depending on how you define self-employment, yes. Accountant Nisall notes that while "everyone who doesn't work for another person or business is self-employed," this does not mean that they are necessarily a target. According to Nisall, returns with a Schedule C are picked at a higher rate than those without them, and for good cause. "What people normally mean is that 'Schedule C firms get audited more often,' and that is accurate to some extent." In the viewpoint of the IRS, a lone proprietor is the business and vice versa. This implies that there is no separation between the two, just as there isn't one between a shareholder and the corporation to which they are a shareholder.
This makes it incredibly simple to combine funds and use them for one's own benefit. Additionally, it is quite simple for the owners of sole proprietorships to neglect to disclose cash revenue and take liberties with household expenses as company deductions because so many of them are cash-based and don't require huge office spaces. Even so, there is a slim probability that your tax return will be inspected simply because a Schedule C was included. Even those who reported incomes between $200,000 and $1 million only saw a 1.4% audit rate.
IRS Will Seize Everything and Arrest Me
No one is imprisoned in the US for failing to pay taxes. Tax fraud is punishable by imprisonment, although being insolvent and owing money is not. It would would take a lot for the IRS to indict you for fraud. When it comes to tax offenses significant enough to warrant prison time, the IRS has a very high burden of proof. Additionally, the IRS cannot just seize your property, car, or bank account. Additionally, the organization cannot seize your wages merely because you owe money. The IRS is required to offer you written notice and an opportunity to contest the amount it asserts you owe. All collections must stop as soon as you file a challenge, and if you sue the revenue service, you may tie its hands for years. You have numerous options, such as paying in installments or modifying the tax withholdings with your present employer, if it's not a major issue but you lack the funds to pay off your IRS bills.
Audits are always conducted right away.
Think again. Three to four months after the filing date is usually when the auditing process starts. Additionally, the IRS can typically conduct an audit up to three years after a return was filed or became due, whichever comes first. Simply said, the IRS must review millions of documents, which takes time. This rule does have several exceptions, which we've noted below:
- If you withheld more than 25% of your income, the three-year restriction is doubled to six.
- If you failed to include more than $5,000 in foreign income, it is also doubled.
- If you never file a return, the IRS has no time restrictions.
- The duration of fraud is unlimited.
- Failure to claim foreign assets has no time restriction.
There are additional difficulties as well. Your state, for instance, might have its own clock and restrictions. For instance, the usual statute of limitations in California is four years.
Filing Multiple Claims Increases Your Chances of Being Audited
You should be fine if you've legitimately submitted multiple tax deductions or credits. The goal of credits and deductions is to lessen the burden of a large payment. You only encounter issues if you knowingly filed for particular credits or deductions, including the aforementioned earned income tax credit. especially now that the IRS is aware that there are millions of false claims for this credit. Overestimating charity contributions is another common issue that taxpayers experience. It is common knowledge that donations can be written off, but most individuals are unaware that they must be itemized. Overestimating the value of these charitable contributions may also result in an audit. Being as truthful as you can when it comes to deductions and credits is the answer. The IRS won't audit you if you don't try to defraud it. And be prepared with backup evidence in case agents appear.
If I Received a Refund, I'm Good to Go
You could believe that since the IRS accepted your return and issued a refund, you are now exempt from further liability. But it's not always the case. The IRS claims that it strives to audit tax returns as soon as possible after they are filed, but in reality, due to the volume of returns it must process, it may take some time to do so. The IRS states on its website that "the majority of audits will be of returns filed with the last two years." A computerized system that scans for statistics that deviate from the statistical averages for comparable returns will occasionally identify returns for audits. Additionally, the IRS occasionally chooses returns for audits based on problems or transactions involving investors or business partners who have already been singled out for inspection.
Based on data that has been forwarded to the IRS by outside sources, your return may also be chosen for audit. You are more likely to be audited, for example, if the income you reported does not match the data on a 1099 or W-2 form. If your return is pulled, a skilled auditor will examine it more closely. Sometimes, the person may choose to accept the return in the end. However, if the auditor notices anything that seems suspect, they will note it and send it to a panel of examiners for a more thorough audit. Also keep in mind that the IRS has a maximum of three years, and occasionally even six years, to audit you. These are just a handful of the most widespread misconceptions you'll encounter regarding audits throughout tax season. The moral of the story is that you won't have to worry if you get audited if you don't defraud the IRS.