For many a taxpayer, an IRS audit conjures up images of the accused being grilled under hot lights by an angry government official. In reality, it's usually not that bad, but it's still something to be avoided at all costs if possible.
Fortunately, the IRS audit process—highly exaggerated to begin with—clearly became more benign following a 1998 reform that emphasized taxpayer rights. Audits declined after 1998, then climbed a bit before the financial crisis.
In any event, no one wants to be challenged to justify an obscure line in the 1040 that can be so confusing even the most honest taxpayer can get something wrong. And taxpayers often face unfamiliar issues that raise their audit risk. For example, for the first time this year, millions will have to take into account subsidies they received under the Affordable Care Act, or Obamacare.
So with the April 15 filing deadline bearing down on us, here are eight keys to avoiding an audit.
—By Jeff Brown, special to CNBC.com
Posted 07 April 2015
While you may have heard of the perils of claiming a home office or deducting expenses on a rental property, most audits involve mundane matters.
"Math errors are always on top of the list," said Cindy Hockenberry, manager of the Tax Knowledge Center of the National Association of Tax Professionals. Another common audit trigger is a space on the return that was mistakenly left blank, she said.
Charitable donations are a frequent IRS concern, according to tax experts, because many people fail to obtain the required documentation furnished by the charity.
"Regardless of the amount of the charitable contribution—it could be a dollar in a red bucket last Christmastime—you need to have some sort of receipt" for any contribution that is claimed, Hockenberry said.
"The most common things [triggering IRS inquiries] are simple mistakes, like a Social Security number that doesn't match the name in the Social Security database, or a column of numbers that simply doesn't add up," said Mark Luscombe, principal federal tax analyst for Wolters Kluwer Tax & Accounting US.
Another common audit trigger is a figure in the return that does not match one on a form the IRS received from another source, like the W-2 income form from the employer or a 1099 from the bank, brokerage or mutual fund company, said Greg Rosica, one of the authors of "The Ernst & Young Tax Guide for 2015." Even casino winnings are reported to the IRS, he noted.
Rosica urges filers to reduce the chance of errors by leaving plenty of time to fill out the return, including a day or so to set it aside before taking a fresh look prior to filing.
People with big incomes are more likely to be audited than people with small ones, Luscombe said. The IRS is likely to inquire if a taxpayer claims as a dependent someone who is not eligible. They also often check to see if the taxpayer files a return, if required, for the alternative minimum tax.
That said, you might have another unexpected friend in the government (Congress), and you probably aren't the one with the really big income: that would be a corporation.
"Now we're in a period where Congress is sort of mad at the IRS over various things and is restricting their budget, causing audit rates to somewhat decline again," Luscombe said.
Hockenberry said that as a result, the agency has concluded it "gets more bang for the buck going after businesses."
Errors creep into returns after taxpayers have a life-changing event that alters their filing status. "Whether you had a baby, got married or divorced or bought a house, all those things have implications for the tax return," Rosica said.
Because 2014 was the first year for Obamacare, many taxpayers may find the filing requirements confusing. While a federal health insurance subsidy may not be taxable, some large subsidies must be paid back. The numbers must be properly reported on Form 8962, said Jackie Perlman, principal tax research analyst at H&R Block's Tax Institute.
"You do need to do it, and if you try to send your return in without that form, you will hear from the IRS and your return will be held up," she said. Another new form, 8965, is used to claim an exemption from the health insurance mandate.
Because tax rules are often the product of haggling in Congress, it's dangerous to rely on logic when filling out the return. Since many business expenses are deductible, for instance, it may seem logical to claim commuting expenses, Perlman said. But for ordinary taxpayers, commuting costs are not deductible.
Aside from the Obamacare requirements, ordinary individual taxpayers face no dramatic changes in filing requirements this year, experts say, and the odds of being audited are small. "I would say, on the whole it's a minor worry, unless you have something very unusual" in the return, Luscombe said.
But tax experts still advise against any attempt to fudge your numbers thinking the risk of an audit is small. "Sometimes that's called 'playing the audit lottery game,' and it's not a good game to play," Perlman said.
Keep in mind that the following will always attract the attention of the IRS:
Overall, the IRS audits just under 1 percent of individual returns, and of that only a fraction involve a face-to-face meeting with an IRS agent.
"That's not a very high audit rate," Luscombe said. "That 1 percent would have something that sort of sticks out as unusual—unusually high deductions for that income level and that sort of thing."
Though it's possible to be fined or even to go to prison for a deliberate tax fraud, most IRS tax inquiries are resolved by mail. "A lot of audits these days are conducted through correspondence. They send you a letter," Hockenberry said. "It's just a matter of clearing things up, so to speak."
And if you get a letter saying the IRS needs more information, don't panic, Perlman said.
If you are audited, think about getting help from a professional, like an accountant, tax preparer or tax lawyer, especially if you disagree with the position taken by the IRS.
Perlman said taxpayers do well to remember that once an audit begins, the IRS can explore any subject, not just the issue that triggered the inquiry. That's why those simple matters like math errors and blank spaces are so important.
The key to avoiding an audit, then, is not to avoid claiming a home office or charitable donation you are entitled to, but to make sure you have documents to back up everything you report in your return.
Most important: If the IRS asks you to substantiate an item in your return, do it.
"That sounds ridiculously obvious, but you would be surprised how many people put it off or ignore it," Perlman said. "They will work with you," she added, "but they don't like being ignored."