It's Tax Season: Don't Fear The Audit
April 15, 2019
The 2019 tax-filing season just began, and for a good measure of folks, so did that niggling knot in the gut. Not that you’ve done or intend to do anything underhanded, but right on time the annual anxiety arrives. It shouldn’t.
When it comes to tax preparation, the second biggest mistake many business owners make is nearly as important as the first, and that’s fearing rather than respecting the Internal Revenue Service. They are apprehensive to take deductions they rightly deserve, for fear of raising the proverbial red flag.
But what are your chances of being audited? Current stats might surprise you. In fact, the overall odds of being audited are so low that most legitimate deductions aren’t likely to send up red flags at all.
Considering the potential tax season chaos caused by the longest partial government shutdown in our history — and that only about 57 percent of IRS employees remain in the workforce in January — the IRS clearly has much bigger things to worry about. Issuing tax refunds in a timely manner and maintaining a measure of order with this year’s tax filings will likely be IRS priority.
Add to this, the agency was already trimmed back, even though the number of Americans filing has grown (150 million individual tax returns were filed in the fiscal year that ended in September). And audit rates already had dropped to historic lows (down 40 percent from 2010 to 2017). The IRS only audited .5 percent of all tax returns filed for the fiscal year 2016, which marks the lowest percentage of audits since 2003.
So, for the average American, the odds of being audited are a chance of about one in 160. The odds are lower if you’re in the middle- or lower-income range and your taxes are fairly straightforward. (On the flipside of these figures, audit odds increase with significantly higher incomes and complicated tax returns.)
Roughly half of the audits the IRS conducted centered on a single issue — the Earned Income Tax Credit for low-income working families. The rest focused on small businesses, especially sole proprietorships. Think: industries such as pizza parlors and coin-op laundromats, where significant opportunities exist for hiding income and skimming profits. In fact, the IRS publishes an entire series of audit guides to download from its website that tells exactly what its agents look for when auditing people.
So if you do get audited, what then? Well, if you’ve accurately documented your legitimate deductions, you have little to fear. Of the 1.1 million tax returns the IRS audited last year, almost 34,000 audits actually resulted in additional refunds to taxpayers. (Another 20 percent of audits typically result in no change either way.).
And if you lose? You’ll get what the IRS calls a deficiency notice, which is simply a bill for more tax. If you still think you’re right, then you can appeal it to the IRS. If you don’t like the result, you can appeal to the U.S. Tax Court. There’s even a small claims division for disputes regarding amounts less than $50,000.
Just how aggressive can you get before risking actual penalties (as opposed to merely paying more tax)? You can avoid accuracy-related penalties if you have a reasonable basis for taking a position on your return. Generally this means your position has more than one chance in three of being accepted by the IRS.
Still concerned? Consider this: for fiscal year 2016, the IRS initiated only 3,395 criminal investigations. That’s an almost unimaginably tiny fraction of the 240 million returns it collects in a year. Of those investigations, the IRS recommended 2,744 prosecutions. (IRS investigators don’t actually prosecute; they turn that job over to the Department of Justice.) There were 2,669 convictions that led to sentencing — the Feds don’t take you to court if they’re not already pretty sure they can win.
In the end, the average honest tax filer really has nothing to fear from the IRS Criminal Investigations unit. Here’s the bottom line: Never be afraid to take a legitimate deduction. And if your tax professional recommends you avoid taking advantage of a strategy you think you deserve, ask him or her to explain exactly why. Don’t be satisfied with a vague “It will raise a red flag” reply. Remember, it’s your money on the table.