The IRS audits hundreds of thousands of individual tax returns every year.
The percentage of individuals audited is quite low compared to previous decades. But that doesn’t mean you can be more careless with your tax returns.
Overall, people who claim to have no income are the most likely to be audited.
But around 1 to 4 per thousand American individuals who make less than $1 million are audited each year. Overall, large corporations are many times more likely to be audited. The average taxpayer is relatively shielded from IRS eyes.
You too are very unlikely to be audited as long as you follow a simple list of steps.
In this article, we will go over:
An IRS audit can be triggered by several factors.
These are the “red flags” its agents are always looking out for. They rely heavily on computer systems, which means that these red flags are easily discovered.
In general, discrepancies are the cause of most personal IRS audits. If you report information that is contradicted by either yourself or a third party, that may trigger an audit. But “discrepancies” can also include information seen as unrealistic for any other reason.
Making a very large income makes you a more likely target for the IRS.
Most people who are audited are not rich, as most people are not rich. But as the IRS statements show, the chances of being audited grow quickly and are much higher for those with six-figure and higher incomes.
A higher income does not necessarily mean that one is underreporting their income. But from the IRS’s point of view, it means they are more likely to make mistakes on their returns.
People with very high incomes tend to have more varied and complex tax returns. Those with lower incomes often have one simple salary, plus a few alternative sources of income. But there are more complex IRS regulations for people who produce various types of income in one financial year:
If you’re quite wealthy and want to avoid an IRS audit, you should hire a competent accountant. You will have to be honest with them and ensure you’re thorough with the information you provide.
You don’t need to be rich to be a more likely target for the IRS.
The IRS is more likely to audit those with less common types of income. That means that if you don’t just hold a simple job and file a Form 1040, you’re more likely to be audited.
Having a simple full-time job makes taxes far easier. Employers also report employee income to the IRS, sometimes while withholding the employees’ taxes from each paycheck. This creates an extremely simple path for every employee.
Those who are running a business, are self-employed, or otherwise compensated have a more difficult time. If this describes you, there are two ways to avoid an IRS audit:
If you’re an employee of a corporation, your employer will also report your income to the IRS.
Should your returns contradict what your employer reported, you are far more likely to be audited.
Remember to be honest and double-check everything you include in your tax returns. Deliberately lying, especially in the above case, is the easiest way to get in trouble.
Even if you’re not a full-time employee, there are almost certainly third parties reporting your income to the IRS.
An IRS e-file matching program compares your own reports with third-party reports. The other common third party is your bank. That means if you report an income that doesn’t line up with what your employer(s) and bank(s) report, you may trigger an audit.
Caution, honesty, and thorough reporting to tax accountants are again the best way to avoid this problem.
US citizens with foreign bank accounts and incomes may be liable for double taxation.
There are thresholds for the minimum income to trigger taxation, however.
The Foreign Bank Account Report is supposed to be reported to the IRS. It is filed through the Financial Crimes Enforcement Network (FinCEN).
When it comes to enforcing foreign income taxation, matters get a bit foggy. But what you should remember is that the IRS can possibly audit foreign bank account income through:
This issue can be addressed by professionals well-versed in foreign income taxation for US citizens. You can address it yourself too, but make sure you thoroughly research your obligations.
You don’t always need a business to claim business losses.
They are sometimes claimed to offset personal income-related expenses, such as things you need for your trade or stationery.
Some people use this to claim the wrong kind of expenses. Including expenses related to a hobby or something not related to your occupation can trigger an audit.
The only way to avoid this is to be sure to only claim losses that are entirely related to your occupation. If you use it outside of work more than for your occupation, claiming it may alert the IRS.
As with criminal law, a statute of limitations exists for audits.
Their statute of limitations begins on the day when you first filed your tax returns.
According to the IRS, when they conduct an audit, they look into the last three years. So if you think your tax returns weren’t completely perfect for the last few years, you have even more reason to avoid being audited. In extreme cases, they may look back further, but very rarely look back more than 6 years.
The IRS can request an extension to the statute of limitations if they feel it’s necessary to look back more than 3 years.
Theoretically, they can potentially look back into your entire tax history. However, that is extremely rare.
You can protect yourself from IRS audits by being honest and thorough when filing your taxes.
In cases where you are unsure, you can hire a professional to help you file your taxes.
When your income is varied or in any way unusual, sticking to the above becomes more difficult and important. This is especially true if your income has increased significantly in recent years.
