It’s estimated that only about 1 percent of taxpayers are audited by the Internal Revenue Service (IRS). If you’re playing by percentages and filing your taxes on time and correctly, chances are you’ll never hear a peep out of them. But for the taxpayers that do, seeing the words “you’re being audited” on a letter from the IRS can be frustrating, annoying and potentially very costly.
Specifically, being audited means that the IRS is checking up on you and your finances to ensure that your taxes were filed correctly. Although it’s not unheard of for the IRS to randomly select taxpayers and businesses to audit, the decision to audit is normally triggered by some sort of statistical outlier on your tax return compared to a pool of similar tax returns that yours is grouped in. The IRS is also more likely to audit the more high-income taxpayers. For instance in 2008, some 5.6 percent of those audited made more than $1 million, whereas fewer than 1 percent of taxpayers making less than $200,000 were audited.
We already told you about why the IRS may order an audit based on the statistical discrepancy reasoning, but here’s a look at more of the specific situations in which the IRS could check up on you and your tax returns:
- Improper Tax Deductions: When filing your taxes, it’s important to be truthful. And a common area where people either make a mistake or fudge the numbers a tad is in tax deductions. There are even certain deductions that send “red flags” to the IRS, such as deducting business expenses that were not reimbursed.
- W-2/1099 Discrepancies: Businesses are required to submit W-2 forms and 1099 forms to the IRS for each person they employ. And these forms are always cross-referenced by the IRS with the taxpayer them self. So if the numbers don’t add up between the two forms that were submitted on behalf of the business and by the employee, the computers the IRS uses will catch it. The result could be an audit, either to the business itself or the employee taxpayer.
- Schedule C: Solo proprietors are required to fill out Schedule C forms, which detail profits or loss from a business. Solo proprietors pay significantly less in taxes than those that are incorporated, so the IRS more carefully examines these forms to make sure you’re paying the correct amount of taxes. Even if you file correctly, the IRS may still want verification.
- Early Filing: Believe it or not, timeliness may not be in your favor when filing. It’s projected that those who file their taxes closer to the deadline are less likely to be audited compared to those who file early.
- Entertaining: If you own a business, chances are at one time or another you’re going to be out there entertaining customers. Businesses can claim up to 50 percent of dining and entertainment expenses on their tax returns. However, the IRS doesn’t like to see expensive parties written off and may ask for clarification between what’s an entertainment expense or just a regular business expense.
Bottom line: To avoid being audited, always be truthful on your tax return. You might even consider hiring an expert to help you understand what can and cannot be deducted when filing. If you have IRS tax issues, learn how to stop wage garnishment problems from a reputable tax attorney.