There is not much that you can do to reduce your chances ofIRS auditbecause the formula for calculating who gets audited is not common knowledge. Be aware that certain items and too manytax deductionsare known to be what triggers anIRS audit. When this occurs, they are looking to get something back and are very certain they’ll get it. The IRS has identified virtual currency fraud as a top priority, and has partnered with both financial and cybercrime investigation units to search for unreported or improperly reported virtual currency-related income. While early virtual currency investors may have utilized the IRS’ incompetence to their benefit, it is highly unlikely that such methods will continue to be successful. The IRS will ask for your wallet ID and blockchain addresses to gather detailed information about any virtual currency transactions. You may be asking yourself: “If theIRS auditsmy virtual currencytax returns, can they also audit my non-virtual currency income?” Given the ambiguous nature of regulations surrounding the taxation ofcryptocurrencyand NFTs, it is highly unlikely that improperly filed virtual currencytax returnscorrelate with improperly filedincome taxes. At this stage in the process, the IRS is simply interested in enforcing virtual currency taxation compliance. Generally, the IRS has no issue with small refunds because predicting the exact amount of withholdings needed over the course of the year is a difficult task, especially when factoring in deductions. However, large refunds pose an entirely different problem for the IRS and it has nothing to do with them not wanting to write a large check to thetaxpayer. First, most large refunds are not associated with standard W2taxpayers, but rather are indicative of large losses on ataxpayer’s return or something that has offset a large amount of tax that thetaxpayerwould have had to pay.As a result, these issues are usually much more technical than a standard return and, therefore, the IRS will usually want to take a second look at those parts of the return to make sure you are right. The good news is that if your calculations are right, your return may come off the manual reviewer’s desk in a short time, barring other problems. The same issue exists when ataxpayershows a net operating loss that is carried over from a prior year. Even manytax preparersmake mistakes when reporting net operating losses on a client’s return, the IRS may examine this section of it due to the potentially high margin of error. Mistakes andmath errorsare indicative of a lack of care when preparing the return. Zeros, especially double or triple zero, indicate that thetax preparerguessed regarding an expense category or are guessing. I have seen IRS revenue agents (auditors) roll their eyes when they see complicated expense categories come out as a nice even number. They often just know that thetaxpayeris not going to be able to substantiate that category fully. In the same regard, guessing and using the same end number over and over again may also raise ared flagwith the IRS. Mosttax professionalswould never advise someone to guess on atax return, but if you are truly stumped and need to make your most honest recollection about an expense category then you might want to vary those guesses to avoid scrutiny. Of course, it never hurts todouble-checkyour math. Probably one of the mainIRS audittriggersis a large change of income. Of course, there are many unexpected events in life that can cause changes in income such as a loss in job, a windfall gain, or just unexpected good or bad luck in life. As such, unexpected and significant swings in income can usually be explained fairly easily. However, large inconsistencies in income from year to year may indicate an area of concern to the IRS if the change in income is not readily apparent (i.e. losses of a job would be reflected by a W2). This is because large shifts in income can also be indicative of someone hiding income in a current or pasttax year. By taking a closer look at the income earned in different years (as well as the substantiating documents), the IRS can sometimes finddiscrepanciesin what ataxpayerearned vs. what they reported.Why would theIRS audityou? 10IRS audittriggers
1.Cryptocurrencya.k.a., Virtual Currency Transactions
2. Large Refunds/Net Operating Losses (NOLs)
3. Mistakes andmath errors
4. Large changes of income
5. Taking ahome office deduction
If I were asked to name three IRSred flagswhere I saw clients get challenged and usually resulted in a change, this category might top my list.
Home office deductionsand the associated expenses for individuals whose company has a primary location somewhere else tends to traptaxpayerswho are not completely familiar with the nuances of the code. Many people misinterpret the rules associated with the deduction while others simply abuse or try and game the system.
The most difficult arguments to make with the IRS are with thosetaxpayerswho receive a W-2 and are someone else’s employee while still claiming a substantialhome office deductionfor the use of their business.
It is really hard to make an argument, absent special circ*mstances, that an employer either does not provide a suitable primary office location for the employee’s position or does not reimburse them for the out-of-pocket-costs associated with setting up a home office.
Furthermore, some occupations statistically do not normally require home offices. It therefore seems obvious that IRSred flagsmay be raised when you are in one of these professions and claim ahome office deductionon yourtax return.
Just be careful when claiming the deduction (or anyitemized deductions) and always keep good records, including photos of the office environment. If you claim the deduction, know that you are likely increasing your chances of an audit and be prepared for a potential uphill battle.
6. Filing aSchedule C
Mostself-employedtaxpayersaresmall businessowners who run sole proprietorships and therefore must report the income derived from it as part of theirindividualtax returns. The IRS will also expect to see aSchedule Cattached, showing thebusiness income, both its profits or losses. Keeping allbusiness expenses,credit cardreceipts and documentation up-to-date is almost mandatory, especially if you don’t use aCPA.
7. Using round numbers
Mistakes are indicative of a lack of care when preparing the return. Zeros, especially double or triple zero, indicate that thetax preparerguessed regarding an expense category or are guessing. I have seen IRS revenue agents (auditors) roll their eyes when they see complicated expense categories come out as a nice even number.
They often just know that thetaxpayeris not going to be able to substantiate that category fully. In the same regard, guessing and using the same end number over and over again may also raise ared flagwith the IRS.
I would never advise someone to guess on atax return, but if you are truly stumped and need to make your most honest recollection about an expense category then you might want to vary those guesses to avoid scrutiny.
8. Reporting a high volume of cash transactions
Cash is a major auditred flagbecause it creates all sorts of problems for the IRS. It is almost impossible to track cash transactions, it can be easily hidden, most often does not have a clear electronic record to track, and is difficult for the IRS to verify.
One of the big fights that the IRS has been waging for years has been against cash businesses. Hospitality workers who do not report their tips, taxi drivers who collect off-meter fares, retail store owners who sell merchandise off-book, etc.
Cash transactions go unreported by a great manytaxpayers, many of whom believe that they do not have to report the cash (wrong) or who figure that the IRS will never know that thetaxpayerreceived cash.
Specifically, the IRS targets returns wheretaxpayersmay deal with large amounts of cash and consider it an auditred flagwhen a return contains a high probability ofunreported income. The IRS does this by looking for these three methods of fraud:
- Skimming – taking cash from a business prior to it being recorded as a sale. For example, a clerk in a store who does not ring up a transaction and pockets the cash.
- Embezzlement – taking cash after a sale has been recorded. For example, a clerk in a store who takes money out of the cash register.
- Fraudulent Transfers – A transfer of funds listed as an expense when it actually should be recorded as income. For example, a payment listed as being to a vendor that is actually taken by an owner or employee.
These examples illustrate methods thattaxpayerswho deal with lots of cash use to cheat the IRS. They should provide you with a rough idea for the types of things the IRS is looking for when they audit a cash return. As a result,taxpayerswho frequently deal in cash will likely receive increased scrutiny by the IRS.
Another auditred flagrelated to cash (and one that the IRS has been targeting) is thetaxpayerwho makes cash transactions in excess of ten thousand dollars. Banks and other financial institutions are required to fill out currency transaction reports (CTRs) when an individual pays, deposits, or otherwise utilizes over ten thousand in cash.
In addition, those who deposit lesser amounts to try and avoid the CTR (which is called structuring and is illegal) or who otherwise participate in a suspect activity risk having a suspicious activity report (SFR) filed against them.
It is not entirely clear how much these items affect a person’s audit risk. However, it is clear that these documents are reported to and kept track of by the IRS.
9. Having cash or assets in another country
Even thoughtaxpayersmay have perfectly legitimate reasons for engaging in cross border transactions, may own property in other countries and use aforeign bank, such activities make the IRS nervous for a variety of reasons.
First and foremost, the IRS summons authority and the ability of the IRS to demand records from third parties (banks, financial institutions) in foreign countries is extremely limited. Particularly in countries with strong bank secrecy laws. The IRS may not find out about the existence of these assets unless they are voluntarily disclosed by thetaxpayer.
Furthermore, cross-border transactions and hiding assets in foreign countries are often used methods to evade taxes. As such, the IRS now requirestaxpayersto disclose if they have foreign assets on theirtax returns.
They can seek prosecution if ataxpayerlies about it and is particularly cautious of US persons that do. Although the IRS will not audit everyone who has assets or transacts business internationally, your risk of an audit may increase if you do.
It should also be noted that the IRS has increased enforcement efforts against businesses with locations right on the US/Mexico border, particularly those that may deal with large amounts of cash. If you do operate asmall businesslike this, there is an excellent chance you will get audited.
10. You have a high income
If your income falls between $1 million and $10 million per year, you are more likely than any other group oftaxpayersto get audited, with theaverage audit rate in 2015 of 2.53%.
However, the number of field audits have dropped for high-income earners and most are now completed through correspondence. Because of their complexity, some high-income audits can take years to complete.
About how manytax returnsare selected by the IRS for audits each year?
Every year, the IRS sends out thousands of notices totaxpayersinforming them that they have been selected for anIRS audit. Even though most honest people who keep good records have nothing to fear, no one likes to be audited.
Audits are scary situations for manytaxpayers. They involve the government prying into personal financial affairs and requesting sometimes very sensitive financial information.They can and do provoke feelings of fear that thetaxpayerhas done something wrong in the eyes of the government.
What percentage oftax returnsare audited? Your chance is actually very low — this year, 2022, the individual’s odds of being audited by the IRS is around 0.4%. However, keep alert for theIRS audittriggers. Are you a high income earner? Do you trade incryptocurrency? Did you file aSchedule C? These factors could increase the likelihood that you will get audited.
What to do if you get audited by IRS
To begin with, you will receive an informational document request from the IRS. This will include items like bank statements, invoices and receipts. The auditor will request information surrounding the examination of whatevertax returnthey have decided to put through an audit.Usually,IRS auditsgo back three years. Thetaxpayergathers those documents and will then either correspond or meet with the auditor to review them.
Most audits will focus either on the income side of things or on the deduction side of things. Occasionally, they will focus on both. Here is what to do when the audit starts:
1. Cooperate with the auditor regarding any requests for information. This is not the time to challenge them.
If you refuse to provide the auditor with the documentation they request, they can always get a summons, then you will wind up in district court. You definitely do not want to be there. The IRS can also issue a summons to get information from a third-party, such as your bank.
2. Thetaxpayeror their representative meets with the auditor who will go through the substantiation with thetaxpayerand/or their representative.
The duration of the audit will depend on what the IRS is looking for. Typically, it should take only one or two meetings. However, if the auditor has to spend a lot of time tracking down documentation, it could take much, much longer.
At the end of the review, the auditor will make adjustments based on what they feel is owed to the government. This will be presented to thetaxpayeras anaudit report.
If your audit drags on for many months or you are having multiple meetings with the auditor, then something is seriously wrong.
3. YOU must control the audit, not the other way around.
Keep the auditor focused on the main objective and have all of your information available and in a format that makes the auditor’s job easy. Quick tip: if you want to score major points with the auditor, be organized. Keep all documentation as clean and tight as possible.
Keep in mind, too, that auditors can be very clever – using your own words and statements to trap you. An IRS audit attorneyknows this and makes every attempt to be certain the audit stays in the client’s control.
4. Once the audit is completed, if thetaxpayeragrees with the audit report, then the audit is over.
If thetaxpayeror the representative disagrees with the report, they may submit additional documentation or work to clarify things in the audit report.
If the auditor and thetaxpayerultimately cannot agree, then the case goes to appeals where thetaxpayercan further challenge the audit.
Take the first step towards decreasing your chances of being audited by the IRS in 2022
I like to say that everybody'stax returntells a story. It’s a treasure trove of information. It says who you are, it says where you live, it says how you earn a living. It gives the IRS information about your income, your deductions and the way that you live your life.
The IRS looks at the relationships between the numbers in your return. If there are pieces missing or facts and numbers that don’t correlate, they may want to investigate. Therefore is more likely that it will select that kind oftax returnfor audit.
Generally speaking, though, there's not much that you can do to decrease your chance of being audited by the IRS in 2022 or any other year unless the formula for calculating who gets audited and who does not becomes common knowledge instead of a state secret.
If you're selected for audit you may not know the reason why, you may not know if your story is out of sync, but rest assured the IRS is not going to undergo an audit unless it has the expectation that you're going to pay more in tax. This is also why you should carefully consider getting tax audit representation, preferably the legal kind.
Is the IRS auditing you? There’s definitely a reason you’re being targeted. There are four different types of IRS audits, too, so figure out which one it is before you start to panic. Then, give my office a call to set up a consultation. Together, we can devise a tax action plan that could help you get rid of those deepening worry lines on your forehead as well as save you a lot of money.
Some final points on what triggers atax audit
The IRS tends to measure the propensity for error that is likely to occur when theIRS auditsthe return and the potential forunreported incomethat may be associated with the return. An auditor who finds errors on a return is then more likely to dig until they are satisfied that they found all the errors that could possibly exist on the return.
The shorter version is the IRS has limited resources so is trying to maximize those resources to yield as much back to the government as possible and to keeptaxpayersin compliance.
My best advice is to make sure your substantiation is scrupulous, organized, up-to-date and includes proof of when you mailed your returns. The difference between winning and losing yourtax auditcould depend on your records. If you do get audited, your income and deduction story will need all the supporting evidence. This way, you may only suffer a few uncomfortable hours that will end with a no change letter, a relieved smile and big sigh of relief.
FAQs
Can theIRS audityou every year?
In short, the answer is yes, there is no rule to prevent the IRS from auditing you every year. Suspicious activities can trigger an audit, but there is no definitive reason for the IRS not to audittax payersat specific times and for specific reasons.
How many times can theIRS audityou?
The IRS can audit you only onetax yearat a time. But they can audit you one year after another if they find auditable triggers. Remember – the IRS has a limited three-year time frame as of atax year's filing deadline, or six years for special circ*mstances.
And, if you never file, file a fraudulent return oromit certain tax forms, there’s no time limit.
When does theIRS audittax returns?
TheIRS websitestatestax returnsare audited “as soon as possible after they are filed. Most audits will be returns filed within the last two years.“ Their examination cycle dictates agents must complete atax auditwithin 26 months after a return was filed or due (whichever is later).
