First, don’t panic. Audits are relatively rare, as fewer than 1% of taxpayers grouped by income level will get that dreaded notice on IRS letterhead.
Per the linked statistics, for the average American who earned $50‒70K per year, only about half a percent of those tax returns got audited. If you made between $25‒50K or between $75‒100K, less than half a percent of those returns were under audit. Only 6.66% of tax returns reporting an eight-figure adjusted gross income were audited as well. Additionally, the IRS has less funding and about one-third fewer agents on board compared to less than a decade ago, so this keeps audit figures down.
To cut to the point right away, your chances are being audited by the IRS are quite slim. There are often many red flags that are likely to trigger an audit, but even then, you’re still more likely to get an examination notice than an actual field audit in which an IRS agent shows up at your door demanding to examine your workspace and files.
An IRS Letter Is Not Likely to Be an Audit
You might think that you’ve been selected for an audit because a letter from the IRS came in the mail that demanded to know why a line item on your tax return was reported a certain way or that they computed your tax bill for you. A notice is not the same thing as an audit.
Most IRS notices are computer-generated with a “CP” prefix. Notices in the CP series will be automatically mailed to you when changes are made to your IRS account, such as making a payment or having all or part of your tax refund seized to pay down your current balance. These notices are sent with the intent to catch discrepancies and underreporting based on information they already have on file, such as if you forgot to report that 1099 you received for giving a side hustle a try or you mistyped your salary as $56,000 when $65,000 was reported on your W-2.
Requests for more information are often referred to as a “desk audit,” but your contact with the IRS is still largely minimal, particularly if your notice pertains to math or input errors.
Common Audit Red Flags
Despite having a pretty low chance of ever being audited, it’s helpful to know which criteria are the most likely to trigger an audit:
- Earning $200,000 or more per year. Don’t pass up that promotion or acting on your entrepreneurial instincts, but your chances of being audited increase once you enter the upper middle class. The higher your income, the higher the likelihood of being audited.
- Home office deduction. Self-employed people in general are far more likely to be audited than people with regular jobs. But your chances go up big time when you take the home office deduction, even though it is a perfectly legitimate write-off. It’s not just the amount deducted, but home office deductions are subject to a “regular and exclusive use” rule that many work-at-home types inadvertently violate without realizing it.
- Suspiciously high charitable contributions. Any larger-than-average deduction is going to arouse suspicion, but charitable contributions are a common red flag. Many people donate to causes they care about, but cash donations are easy to substantiate, as are marketable securities. Did some spring cleaning and gave a lot to Goodwill? People often overvalue non-cash donations and don’t have the time and wherewithal to take pictures and document them unless it’s an extremely valuable item, like donating rare art to a museum that had a professional appraisal.
- Gig work and cash-intensive businesses. Consistent with the high audit rates among the self-employed, any cash-intensive type of work is an audit minefield. While rideshare drivers get a 1099 and can properly track mileage with many apps and tools, discrepancies are still common. Cash-heavy businesses like cafes, laundromats and selling items at craft fairs also provide opportunities to overstate expenses and understate income with little or no substantiation of these numbers.
You should still take advantage of all the tax benefits legally available to you and keep fastidious records you and your tax professional can easily access. This way, you can substantiate any claims if your tax filing situation is more complicated than just getting a W-2 from a job. Nevertheless, these situations are most likely to turn you into an audit statistic—so beware. If you are ever facing an audit, either as an individual taxpayer or a small business owner, you don’t have to go it alone: we can help, contact us today.