How Likely Are You to Get Audited by the IRS?

An Internal Revenue Service (IRS) audit involves a review of an individual’s or organization’s financial records and tax returns. This process ensures that reported information aligns with tax laws and that the correct amount of tax has been paid. While the prospect of an audit can be concerning, it is a routine aspect of the tax system aimed at verifying accuracy and compliance. Receiving an audit notice does not inherently suggest wrongdoing; the IRS conducts audits for various reasons, including statistical sampling and data analysis.

Understanding Tax Audits

The primary purpose of a tax audit is to maintain the integrity of the tax system. This involves verifying reported income, deductions, and credits to ensure taxpayers fulfill their obligations. The IRS employs several methods to select returns for review. Some returns are chosen through random selection, where a statistical formula compares a tax return against “norms” for similar returns.

Computer programs also score each return, with higher scores indicating a greater potential for changes or unreported income based on past IRS experience. The IRS also uses information matching, comparing data reported by third parties, such as W-2s from employers or 1099s from banks, against what is reported on a tax return. If discrepancies arise, an audit might be initiated.

Factors Influencing Audit Selection

Several factors can influence the IRS’s decision to select a tax return for review. One common indicator is a significant discrepancy between reported income and information the IRS receives from third parties. For instance, if income reported on a W-2 or 1099 form does not match the amount listed on the tax return, it can prompt scrutiny. Claiming unusually large deductions relative to one’s income can also attract attention, as these might deviate significantly from statistical norms for similar returns.

Tax returns filed by individuals with high incomes face a higher likelihood of examination. For example, audit rates for those earning over $500,000 increased in 2023. Self-employed individuals who file Schedule C, especially those reporting substantial business losses or claiming 100% business use of a vehicle, may also be subject to closer review. The IRS is attentive to activities considered hobbies rather than legitimate businesses, particularly if they consistently report losses without a reasonable expectation of profit, as outlined in 26 U.S. Code 183.

Certain tax credits, such as the Earned Income Tax Credit (EITC), are prone to errors and can lead to increased scrutiny. Mathematical errors or inconsistent entries can also be indicators for further review. Complex financial situations, including extensive foreign bank accounts or virtual currency transactions, may increase the chance of an audit due to enhanced reporting requirements. A history of previous audit adjustments can also lead to a higher likelihood of future audits.

Preparing for Potential Review

Proactive preparation is a practical approach to tax compliance, whether or not an audit occurs. Maintaining accurate records for all income, deductions, and credits claimed on a tax return is important. This includes retaining W-2s, 1099s, receipts for expenses, bank statements, and any other documents that substantiate financial transactions. For business owners, specific records like mileage logs for vehicle deductions or detailed documentation for home office expenses are particularly relevant.

Organizing these records systematically can significantly streamline the process if information is requested. Taxpayers can choose to keep physical copies, digital scans, or both, categorized by tax year and type of expense or income. While the general statute of limitations for the IRS to audit a return is three years from the date the return was filed or the due date, it can extend to six years if there’s a substantial understatement of income. Therefore, keeping records for at least seven years is a prudent practice to cover potential extended audit periods. Before filing, reviewing the tax return for accuracy and consistency with supporting documents is important.

What Happens During an Audit

An audit commences with an official letter from the IRS, not an unexpected phone call or email, which are often signs of scams. The notification letter will detail the specific tax year being examined and the information requested. The IRS conducts audits in several ways, with the simplest being a correspondence audit, handled entirely by mail. These are common for specific, verifiable items, like a particular deduction or credit.

More complex issues may lead to an office audit, which requires the taxpayer to meet with an IRS agent at a local IRS office. For complex examinations, especially for businesses or intricate individual returns, a field audit may occur. In a field audit, an IRS revenue agent conducts the review at the taxpayer’s home, business, or accountant’s office.

Upon receiving an audit notice, responding timely to the IRS’s request for information is important. The IRS will review the provided documents and may ask for additional clarification or supporting evidence. An audit can conclude with no changes to the tax return, a finding that additional tax is owed, or even a refund due to the taxpayer. If additional tax is owed, interest and penalties may also apply.