The overall number of tax audits continued to decrease with about one million individual returns flagged last year, which equates to less than one percent of all those filed. This number was 16 percent lower than the prior fiscal year.
Why the declining number of audits? The Service has been absorbing budget cuts for five years that have resulted in the loss of 7,000 employees. Proposed cuts continue in the current administration budget. Even as fewer tax audits occur, agents are trying to squeeze more dollars out of each one. It's vital to seek representation from a tax attorney to mitigate the consequences of an audit.
The odds of an audit: Seven-tenths of a percent versus six percent
Looking at overall numbers fails to take into account that certain categories of taxpayers still receive more scrutiny. Earning more income brings with it more IRS interest. For those who earned more than a million, the rate of audits was closer to six percent.
Software will match up what you report with that submitted by third parties, such as an employer or firm that receives consulting services. This will catch an easy data entry error that transposes numbers. In these cases, a notice in the mail will explain the error and whether the IRS believes you owe more tax or should receive a refund.
A secret scoring system has been developed by the Service to identify anomalies that warrant further investigation. Probabilities are what underlie this scoring system. What are some of the things that this algorithm looks for?
Frivolous arguments, small business owners and hobby losses
The easiest way to get into trouble is to refuse to pay in the first place. Taxpayers have tried to argue that taxes are unconstitutional with a sovereign citizen claim. Recently, some others have refused to pay as a protest.
You need to realize that these arguments are generally viewed as frivolous by the tax court. In these cases, interest and hefty penalties can accrue. Collection tools may also be used - a tax lien against your property or passport revocation - are a few in the IRS arsenal.
Small business owners who report income and losses on a Schedule C are less likely to strictly comply with tax laws. A return of a business owner who receives cash payments that are not reported by third parties will receive a close review.
This ties in with the third category of hobby loss rules. These rules are technical and must be followed closely. If a business is not being conducted for a profit, then the losses can only offset the earnings. Here is an example of hobby losses: Expenses related to hotels and flight costs while researching and writing a travel book would probably only be allowed to the extent of the earnings from book sales on Amazon.
Whenever you receive indication that the IRS is launching a formal audit of your tax return, immediately speak with a tax attorney. By obtaining counsel before you respond, you can avoid common mistakes that might make the situation worse.