Learn About Tax Audits
Why Me? Why Was My Tax Return Audited?
Tax returns are selected for audit for a number of reasons. Although only around 1 percent of all Form 1040s are audited, 1 percent of 130,000,000 returns is a lot of audits!
High DIF Scores
Most returns are audited because they have a high "DIF" score. ("DIF" stands for Discriminate Function Analysis--a statistical measure). When you file your tax return the IRS electronically scans it looking for math errors and missing information. While doing this, the IRS computer also compares your return to "average" returns. The computer is looking for numbers on your return that look out of line, or just out-of-the ordinary. For example, a person earning $60,000 who takes a deduction for making a $30,000 charitable gift would be unusual and the deduction would add to the return's DIF score. The more questionable items, the higher the DIF score. If you work for yourself your return likely has a high DIF score, and greater odds of being audited.
Mistakes in Preparation
Common mistakes that trigger audits include: reporting income on the wrong schedule, forgetting to report income from a stock sale or pension distribution, and taking the same deduction twice (very common if you used a computer program to self-prepare your form 1040).
You're Self-Employed
As mentioned earlier, your tax return is far more likely to get audited if you are self-employed (work for yourself). Owners of side or part-time businesses are frequent audit targets. Employees who receive a form W-2 have little opportunity to underreport income. Self-employed taxpayers who report their own income and deductions have both the opportunity and the motive to underreport income or over report deductions. Your chances of being audited triple if you are self-employed.
What To Expect At Your Tax Audit
Take your audit seriously
Failure to take the audit seriously can prove costly. You need to carefully read all the letters from the IRS and provide all the materials requested by the deadlines. Don't expect to skip anything--the auditor will notice.
Stress
Audits are always stressful and time-consuming. It's you against the government, and they make the rules. You don't want to go in alone. Because the government audits tax returns that you filed a few years ago you will be asked about transactions that occurred years ago. The government will continue to send scary-looking bills and document requests during the course of the audit. If you are represented at the audit, in most cases you'll never have to talk to the IRS.
The Auditor's Job
The auditor's job is to verify that the numbers you reported on your tax return are accurate. You need to be able to show: 1) How the numbers were computed and 2) provide books, records and receipts that prove the income and deductions reported on the return. If the auditor has all the receipts and can see how you calculated the numbers on the return, the audit will go quickly. If there are missing documents or if it is hard for anyone to determine how the numbers of the return were calculated, the audit will be longer and more stressful. Although it may seem unfair, this is one area where you are guilty until you prove yourself innocent. You have the burden of proving the truthfulness of the numbers.
Bank Account Statements
The auditor will probably request all your bank account statements. The auditor will be comparing the income you reported on your tax return to the amount of cash you deposited in the bank. The auditor will expect them to match. The auditor will likely add any "unreported" income" to your return which will result in more tax interest and perhaps penalties. However, items like gifts of cash and loans are not taxable. It is up to the taxpayer to be able to explain why more cash went into bank accounts than on the form 1040.
Lost Records
If you moved, were divorced or had a computer hard drive crash you probably lost some records. Many lost records can be duplicated and expenses proved in other ways. The better your records, the easier the audit will be. Contrary to popular belief, credit card records are not enough proof-- If you want to keep all your deductions, you need to keep all your receipts! The burden is on you to be familiar with the IRS' recordkeeping rules.
Link to: IRS Publication 552 Recordkeeping for Individuals
Link to IRS Publication 583 Starting a Business and Keeping Records
What If I Can't Pay?
If you have a tax bill that is too large to pay, the government offers Installment payment arrangements. If you are truly destitute the government may be willing to accept an "offer in compromise" Although most audits do not end in criminal charges, tax fraud can result in fines and jail time.
Link to: IRS Publication 556 Examination of Returns, Appeal Rights, and Claims for Refund www.irs.gov/publications/p556/index.html
Oregon Dept. of Revenue Audits
Oregon Department of Revenue audits are similar to IRS audits. Because Oregon has "adopted" the IRS tax rules, your Oregon tax is largely based on your federal form 1040. Accordingly, at your Oregon tax audit the state auditor will probably be closely examining your federal return as well as the state tax return. When the Oregon auditor increases your income or disallows deductions, the changes also apply to your federal return so both your federal and state tax bills will go up. (If the IRS assesses additional taxes the law requires you to file an "amended" Oregon return reporting the extra income to the state). Don't expect the state audit to be any easier and less stressful than an IRS audit. Most of the tax tips on this website apply equally to the IRS and the Oregon Department of Revenue.
Link to: Oregon Dept of Revenue publications:
Your Rights as an Oregon Taxpayer www.oregon.gov/DOR/PERTAX/800-406.shtml
Don't Go In Alone--You May Overpay Your Taxes
Although you can represent yourself at your tax audit it is generally a good idea to get a tax attorney or other professional to represent you.
A representative will: 1. Talk to the IRS for you. In most cases, once you are represented you will never have to talk to the IRS yourself.
2. Allow you to avoid the stress and embarrassment of appearing at the audit.
Few taxpayers enjoy spending a day or two locked in a small windowless conference room being grilled about their tax records.
3. Allow you to maintain a normal routine. You are able to spend your time running your business and making money, rather than studying complicated tax rules, pouring over your books, records, and receipts, and spending a day or two with an IRS agent.
4. Prevent possible overpayment of taxes. An experienced professional will be well-versed in tax law and IRS procedures. Tax law is complicated, and even IRS auditors mistakenly deny deductions or make other errors that result in taxpayers paying more tax than they actually owe. Having a professional on your side will minimize the chance of this happening.
Representing yourself can be risky because the auditor knows more tax rules and procedures than you do. It's like playing a card game that's new to you against a professional gambler. The odds are against you from the start. Getting professional help evens up your odds at the audit.
If your tax return was prepared and signed by a CPA or EA (Enrolled Agent), that person would be a good choice to represent you at the audit. If you self-prepared the return or had a licensed tax preparer prepare your return, an Attorney-CPA is a good choice to represent you.
Attorney-CPAs
Representation by an Attorney-CPA gives you the best of both worlds. They are knowledgeable about both tax accounting and tax law. If you suspect that you, your spouse, or business partner may be accused of committing a criminal act or tax fraud, you certainly need to consult an attorney before the audit.