Life is full of legitimate financial worries. Do you have enough term life insurance to provide for your family in the event of an untimely death? Does your retirement plan take into account a likely long life expectancy? And are you prepared with long-term care insurance in the case of a disability? These are things worth worrying about and preparing for, yet every year around tax filing time (it’s delayed until July 15 this year due to the COVID-19 pandemic) many people worry themselves silly about being audited by the IRS. And they imagine such an audit will be horrible.
In recent decades, the IRS has sought to publicize high-profile enforcement cases — think lifestyle guru Martha Stewart and actor Wesley Snipes — as a deterrent to tax cheating. And one survey found that Americans would rather undergo a root canal than be audited.
But the reality is far more prosaic and, really, reassuring. Audit activity has been declining steeply for a decade. More than 155 million personal income tax returns were filed by individuals in 2019, but only 0.45% were formally examined. That’s less than half of the rate in 2010.
If you’re among the nearly 698,000 taxpayers whose personal return is getting special attention, your biggest and most immediate challenge is to pull together your invoices, receipts, canceled checks and bank and brokerage records. Yes, it’s a pain, and stressful. But instead of freaking out, think of it as a chance to organize your financial life.
Scrutiny doesn’t automatically mean the IRS thinks you broke the law. Maybe you’re a self-employed web designer with lots of clients, and you simply forgot to include a 1099 you received for a part-time job, a copy of which was also sent to the IRS by whoever paid you.
Of course, if you wildly inflated your deductions, or grossly understated your income, the IRS may suspect as much because your return is out of statistical sync with scores of returns filed by other taxpayers with income and deductions that are similar to your profession. Or maybe you did business with another taxpayer whose own return got singled out, and you’re under the microscope by dint of association. You could also have been chosen randomly.
The lowest audit rates are for middle income and upper middle income Americans. If you made from $75,000 up to $200,000 in 2017, according to the most recent data, you had a 0.44% to 0.45% chance (likely even lower for 2019, given the overall figure was 0.45%) of being audited the next year. Even if you made between $200,000 and under $500,000, you still stood only a 0.53% chance. That’s roughly one-sixth the rate of 2010.
Highest earners have higher audit rates because they tend to have more complicated returns, and thus more room for errors, but also, according to an academic study published in the National Tax Journal, a greater propensity to underreport taxable income. But the chance of being audited is still relatively low. If you had income between $1 million and $5 million in 2017, you stood only a 2.2% chance, barely one-fourth the rate of 2010.
If you’re self-employed, and thus typically claim a lot of deductions, or are a recipient of the earned income tax credit (EITC), a $63 billion annual program for low-income households that is plagued by mistakes and abuse, your chances of being scrutinized go up.
Some audits aren’t technically audits, at least not as the IRS defines them. In these cases, you get a “request for information” letter in the mail — a computer-generated notice indicating that automated screening has picked up garden-variety math mistakes, typos or missing paperwork. Maybe you forgot to report taxable interest from your bank or brokerage account. That’s all stuff that usually you can fix easily. The National Taxpayer Advocate, the independent oversight agency of the IRS, calls these letters “unreal” audits, because they aren’t included in the agency’s official audit statistics.
While your chances are low, expect to owe money. Those under audit who made between $200,000 and $1 million ended up owing roughly $24,500 to $33,300 in additional tax in 2018, depending on whether their review was done in person or by mail.
Those who made from $100,000 to $200,000, owned their own business and didn’t claim the EITC, owed roughly $24,400 to $30,200 in additional tax.
The single most important thing: Never ignore any deadlines laid out in IRS letters. It can prompt the agency to start collecting your outstanding tax bill, plus interest and any fines or penalties, in coming months — including through property liens and wage garnishment. And it can squelch your ability to dispute mistakes. Still, the agency has paused its audit and collection activities to July 15 amid the COVID-19 pandemic.
So, file on time, be honest and worry about other things.
(Article written by Lynnley Browning)