What Are the Chances of Getting Audited by the IRS?

An IRS audit reviews an individual’s or organization’s financial records and tax returns to ensure compliance with tax laws. This examination verifies the accuracy of tax filings and promotes compliance. This article discusses the likelihood of an IRS audit and factors that influence it.

General Audit Statistics

The percentage of individual tax returns selected for an IRS audit remains low. For instance, only 0.2% of individual income tax returns filed for the 2020 and 2021 tax years faced an audit, meaning approximately 1 in 500 returns were examined. This low rate reflects a decline in audit activity, partly due to reduced IRS staffing and resources.

Audit rates vary based on income levels and return complexity. Higher-income taxpayers generally face a greater likelihood of audit. For 2019 tax returns, those earning between $1 million and $5 million had an audit rate of 1.3%, while individuals with incomes over $10 million faced a nearly 9% audit rate. The IRS historically audits higher-income taxpayers at a greater rate. The IRS has indicated a renewed focus on auditing high-income individuals earning $400,000 or more, partly due to increased funding from the Inflation Reduction Act.

Key Indicators Affecting Audit Likelihood

Certain characteristics on a tax return increase the likelihood of an IRS audit. Unusually high deductions relative to reported income often draw scrutiny. For example, claiming $20,000 in deductions on a $25,000 income significantly raises the chance of an audit compared to claiming $2,000. This disproportionate claiming of expenses may suggest inaccuracies or aggressive tax positions.

Significant income fluctuations from year to year can attract attention, as the IRS looks for consistency. Unreported income is a common trigger, especially when third parties like employers or financial institutions report income to the IRS (via W-2s or 1099s) that does not match the taxpayer’s return. The IRS’s automated systems flag these discrepancies, leading to inquiries.

Self-employment income and business deductions are frequently reviewed due to complex calculations and potential for errors. Reporting substantial business losses, particularly for several consecutive years, can invite an audit, especially if the activity appears to be a hobby. The IRS considers an activity a business if it has generated a profit in at least three out of the past five tax years.

Claiming certain tax credits, such as the Earned Income Tax Credit (EITC), can lead to increased scrutiny due to complex eligibility rules and historical fraud. Large cash transactions or gig economy income might be flagged if not fully reported. Mathematical errors, inconsistencies, or the use of excessively round numbers on a tax return can signal inaccuracy. Foreign bank accounts or assets also trigger heightened reporting requirements and audit risk due to international tax compliance efforts, such as the Foreign Account Tax Compliance Act (FATCA).

Types of IRS Audits

The IRS conducts audits through various methods. The most common and least intrusive is the correspondence audit, conducted entirely by mail. These audits focus on one or two specific issues, such as a missing form or a questionable deduction, and comprise the majority of IRS audits. Taxpayers receive a letter (like a 566 letter or CP2000 notice) requesting documentation or clarification, which often resolves the matter.

An office audit requires the taxpayer to appear at a local IRS office for an in-person interview. These audits are used for issues too complex for a correspondence audit but not extensive enough for a field audit. Office audits involve specific items like itemized deductions (Schedule A), business profits or losses (Schedule C), or rental income and expenses (Schedule E).

The most comprehensive type of examination is the field audit. An IRS revenue agent visits the taxpayer’s home, business, or accountant’s office to conduct a thorough review of financial records. These audits are reserved for complex returns, such as those of small businesses or high-net-worth individuals, and involve a detailed examination of many items on the return. Revenue agents are highly trained and may specialize in particular industries.

Proactive Measures for Taxpayer Confidence

Maintaining accurate and organized records is a foundational step for taxpayers. This includes keeping all supporting documents for income, deductions, and credits, such as W-2s, 1099s, receipts, invoices, and bank statements. The IRS recommends retaining tax records for at least three years from the filing date or two years from the tax payment date, whichever is later. For underreporting income by more than 25%, records should be kept for six years; for fraudulent returns or no filing, indefinitely.

Reviewing tax returns for errors or omissions before filing can prevent many issues that attract IRS attention. Mathematical mistakes, transposed digits, or inconsistent entries can flag a return for review. Utilizing tax software can help mitigate errors, but taxpayers should still verify all entered data. Responding promptly and accurately to any IRS notices is important; ignoring correspondence can lead to disallowances or further action.

Seeking professional tax advice is a prudent measure, particularly when navigating complex financial situations, significant life events, or intricate business transactions. A qualified tax professional, such as a Certified Public Accountant (CPA) or Enrolled Agent, can assist with proper reporting and provide representation if an audit occurs. Understanding the tax implications of major financial changes, like starting a business, selling property, or receiving substantial inheritances, helps ensure compliance and supports the accuracy of future filings. Consistent reporting practices year over year, where applicable, also contribute to a stable tax profile.