This essay will walk you through the basics and serve as an introduction to the topic of IRS examinations or “audits”.
My firm, By The Book Taxes, located in Norwalk, CT specializes in income tax preparation for individuals, families and self-employed people. By The Book Taxes represents clients before the IRS and state taxing authorities to help them resolve their tax debts by preparing and filing Installment Payment Agreements, Offers-in-Compromise, Currently Not Collectible and Innocent or Injured Spouse applications. By The Book Taxes also represents clients in 1040 examinations or audits.
The purpose of an IRS examination is not to punish a taxpayer or business but to ensure that the tax return filed is “substantially correct” with respect to reported income, business expenses deducted and tax credits claimed.
One question I always get asked is, “What are my odds of being audited”? In tax year 2018, there were almost 900,000 tax returns examined out of a total of 150 million individual (1040) and corporate tax returns filed. That’s a little more than one-half (0.6%) of one percent.
If you were a W-2 taxpayer with income less than $200,000, you had little chance of being audited. A corporation with assets between $10 million - $50 million had about a 5% chance of being audited. As your income increases, especially if you are self-employed, and the assets of your business increase, so will your chances of being audited.
Tax returns may be selected for examinations because they show indications that there may be unreported income, questionable expense deductions or tax credits claimed that the taxpayer doesn’t qualify for.
The IRS attaches a numerical “DIF Score” to each tax return using the Discriminant Function System. The higher the score, the higher the likelihood that the tax return in question contains the items mentioned above.
The IRS also scrutinizes questionable business or medical deductions like swimming pools, large “business use of the home” deductions and outsized (relative to income) “charitable” deductions.
Examinations of other businesses that interact with a taxpayer could lead to the taxpayer or their business being audited.
Disgruntled ex-employees, ex-business partners and ex-wives are other sources of information that can trigger an audit.
About 75% of examinations are conducted by “correspondence”, which means you respond to a letter (usually the CP2000) sent by the IRS telling you that what you submitted on your return doesn’t match what is reported to them by third-parties like banks, employers and investment firms.
The other 25% of the examinations are conducted “in person” at either your business location or the local IRS office. This was pre-COVID-19.
If you have years of unfiled tax returns or owe money to the IRS, please call me before the IRS finds you. I can help.