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As part of the recently passed Inflation Reduction Act, the IRS has been allocated $80 billion over the next ten years. Yes, billion with a “b”! About half of those funds will be used for enforcement. And while the IRS has pledged that they will not use these funds to increase audits of small businesses and people making under $400,000 a year, we can expect audit rates overall to increase.
So you may be wondering… what are your chances are of being audited? As of today, audit numbers are at an all-time low.
Taxpayers whose returns stray outside of what’s considered normal or have “large, unusual or questionable items” can always be singled out for audit. But overall, statistics show that the IRS likes to audit taxpayers with certain characteristics.
First off, individuals get audited more often than businesses. In 2017 the IRS reported a 1 in 184 or 0.542% chance of being audited for all taxpayers. For taxpayers filing individual returns (Form 1040), the likelihood of an audit is 1 in 161 or 0.623%. Corporations (C Corps and S Corps) and partnerships are audited less than individuals – with an audit rate of 1 in 224 or 0.445%.
Generally the IRS focuses its audit resources on areas where historically taxpayers are non-compliant: International taxpayers, high-wealth taxpayers (gross income over $1 million), and sole proprietors or single-member LLC’s grossing over $100,000. Traditional wage earners who have traceable income reported on a W-2 face much less scrutiny. In fact, in 2017 those taxpayers who made under $200,000 and didn’t claim the Earned Income Tax Credit were the least likely to have been audited. And this group happens to make up about 65% of all taxpayers.
Business & Specialty Returns
Generally the IRS is more likely to audit large corporations with over $10 million in assets, estate tax returns, and excise tax returns. Trust Income tax returns, S-Corps, and Partnerships were the least likely returns to be audited.
It should be noted that audits are not the only way the IRS can question the accuracy of a tax return. Over recent years the IRS has increased their automated return checks in the form of matching programs. One example is the automated under-reporter program where the IRS matches income between tax returns and IRS information (submitted W-2’s, 1099’s, etc.) to look for discrepancies. If there’s a mismatch, the IRS automatically sends out a notice/letter asking for additional information. You are over 3 times more likely to get a letter from the IRS due to this program rather than for an audit.
If you add the automatic matching program to the IRS audit rate for individuals, the chances of the IRS challenging an individual taxpayer’s return increases to 1 in 35 or 2.857%.
How Much Does An Audit Cost?
More likely than not, if you get audited it is going to be costly. IRS data shows that over 90% of individual audits result in a tax change. The average additional tax owed is over $6,000 for a mail/remote audit and nearly $22,000 for a more intensive IRS field audit.
The automatic matching program notices can also be costly. The IRS collected $6.7 billion in additional tax on the 3.3 million matching notices it sent in 2017 – an average of about $2,000 per notice issued.
On top of the additional tax for audits and notices, there are accuracy penalties, which can add 20% to the tax bill.
How Do You Avoid An Audit?
For most taxpayers, to avoid IRS scrutiny you just have to report all wage and income documents (W-2’s, 1099’s, etc.) on your tax return. Tax preparers can’t get IRS informational statements from the IRS before the end of tax season, so they need to rely on their client’s ability to provide them all of the applicable documents.
Candace is the founder of NewWay Accounting and is a CPA who specializes in working with fellow entrepreneurs. She strives to take the fear and anxiety out of taxes and help empower small business owners to feel more confident and in control of their finances.
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