Tax Planning

Five reasons why you shouldn't panic over an IRS audit

Jill Cornfield, special to
Key Points
  • The IRS audited nearly 1.1 million tax returns in 2016, accounting for 0.5 percent of all returns filed that year.
  • Nearly 34,000 of the audits led to a total of $6 billion in additional taxpayer refunds.
  • About 7 in 10 audits during fiscal 2017 took place via correspondence.
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Like a root canal or cross-country move, the prospect of having your tax return audited makes most people panic.

"Nearly everyone has an extreme phobia about IRS audits," said Brian Stoner, a CPA in Burbank, California. "The only exceptions are those who have been audited, and the audit went well."

Generally, the IRS can examine returns that you've filed in the last three years, but it can dig even further back for substantial errors.

You may need to provide copies of documents to substantiate the income, credits and deductions you claimed, including receipts, bills and canceled checks.

Here are five things you may not know about how the IRS chooses its targets.

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Good news! The odds are low

The less you make, the lower your odds, Stoner said. People who make under $200,000 face a less than 1 percent chance of being audited.

The reason is partially because of IRS budget cuts in the last few years. If you earn more than that $200,000, the rate jumps to 4 percent. Even if you make $1 million or more, your odds are still only slightly more than 12 percent.

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You can take that home office deduction

Some people think any deduction is an audit tripwire. In nearly 40 years of practicing, Gail Rosen, a CPA and partner with Wilkin & Guttenplan PC, said she's never seen an audit triggered because someone took the home office deduction.

Remember: It's OK to claim legitimate expenses.

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The IRS loves comparisons

The IRS looks at your numbers with an eye to others in a similar financial situation. "Does your style of living equal that of your peers?" asked Rosen. The IRS website posts statistical averages for income, itemized deductions and exemptions.

"If a tax filing reports something that is sufficiently outside a normal reporting range, the IRS computers may kick out a return for potential audit," said Richard Kollauf, a CPA and certified financial planner at BMO Private Bank.

You're not at the mercy of computers. IRS staffers check to see if there's a reason for numbers outside peer comparisons.

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Financial profiling

The IRS conducts a few random audits to compile data for profiles of typical earners in various brackets. These computer comparison audits help it decide whom to audit in the future, looking at factors such as charitable donations, auto purchases and deductions.

High deductions or significant under-reporting can then flag a return for a potential audit.

The Internal Revenue Service's offices in Washington, D.C.
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Maybe you've been audited and didn't even know it

You might think an audit means visiting the IRS with your shopping bag of receipts. In fact, the IRS has three types: by mail, in one of its offices or in a field audit at your home or office.

The IRS never calls to initiate an examination.

The most common one, the mail audit, may never go beyond correspondence. An anxiety-provoking letter asks you for more specifics on income or a deduction. Answer to the IRS' satisfaction, and that is often the end of it.

Congratulations! You've just survived an audit.