IRS audit rates are historically low, according to a recent Government Accountability Office (GAO) report, but that’s little consolation if your return is among those selected to be examined. Additionally, the Inflation Reduction Act provided the IRS with additional funding in order to enhance customer service, modernize technology, and conduct more audits of high-income taxpayers. Being prepared is the key to surviving an IRS audit.
According to the GAO, individual tax return audit rates declined at all income levels during tax years 2010 to 2019. The audit rate for all returns dropped from 0.9% to 0.25% on average. This is due to less staffing as a result of lower funds, according to IRS officials. High-income individuals, large corporations, and businesses are more likely to undergo an audit, but overall, all types of audits are being done less frequently than they were ten years ago.
Since some tax returns are picked at random for audits, there is no 100% assurance that you won’t be one of them. So being ready in advance is the best way to survive an IRS audit. You should routinely keep records of any transactions that will be reported on your tax returns, such as invoices, bills, canceled checks, receipts, or other proof. Keep all records in one location.
IRS Audit Hot Spots
What might catch the attention of the IRS? There are certain types of tax-return entries that are known to the IRS to commonly have errors, so they may lead to an audit. Here are a few examples:
- Significant inconsistencies between tax returns filed in the past and your most current tax return,
- Gross profit margin or expenses markedly different from those of other businesses in your industry, and
- Miscalculated or unusually high deductions.
Certain types of deductions may be questioned by the IRS because there are strict recordkeeping requirements for them — for example, auto and travel expense deductions. In addition, an owner-employee salary that’s inordinately higher or lower than those in similar companies in his or her location can catch the IRS’s eye, especially if the business is structured as a corporation.
Responding to an IRS Audit Letter
If you’re selected for an audit, you’ll be notified by letter. Generally, the IRS doesn’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.
Many audits simply request that you mail in documentation to support certain deductions you’ve taken. Others may ask you to take receipts and other documents to a local IRS office. Only the harshest version, the field audit, requires meeting with one or more IRS auditors. (Note: Ignore unsolicited email messages about an audit. The IRS doesn’t contact people in this manner. These are scams.)
Keep in mind that the IRS won’t demand an immediate response to a mailed notice. You’ll be informed of the discrepancies in question and given time to prepare. You’ll need to collect and organize all relevant income and expense records. If any records are missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.
If the IRS chooses you for an audit, our firm can help you:
- Understand what the IRS is disputing (it’s not always clear),
- Gather the specific documents and information needed, and
- Respond to the auditor’s inquiries in the most efficient and effective manner.
An audit won’t likely start until a year or more after you submit a return, and the IRS typically has three years to complete one. If the IRS selects you, don’t panic. Most audits are routine. You may lessen the inconvenience of an audit and even reduce the likelihood that you will be selected in the first place by being thorough and proactive about tracking, documenting, and filing the tax-related information for your business.
Our CPAs are happy to help. Contact us for any audit-related questions.
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Originally posted October 2020. Updated February 2023.