by David M. Kendrick, CPA, MST

It may be comforting to know that only a small percentage of all individual tax returns filed each year are audited; however, this isn’t so comforting if your return is selected for exam! The IRS recently released its latest statistics reporting the overall exam rate for individuals increased to 1.1% of all individual returns- the largest percentage since 1997.

Per the IRS’s recently released Annual Data Book, of the 142,823,105 individual income tax returns with a filing requirement, 1,581,394 were audited!  Higher income taxpayers and those with complex transactions face a greater chance of audit. Also, self-employed individuals are far more likely to be audited than businesses operating as an S-corporation or partnership.

One of the most commonly employed methods of selecting returns for audit is based on a statistical model the IRS creates from past returns and exam results. The chance of your return being selected for audit increases if your tax return data falls significantly outside the IRS expectations derived from this model.
 Several additional factors that increase audit risk:
• Your business has a large volume of cash transactions
• Business expenses are large in relation to income reported on your tax return
• Itemized deductions exceed national averages
• You have complex tax transactions without adequate disclosure

The IRS has increased the use of “correspondence audits”.  This is the most common exam technique taking the form of a written request for additional information or a demand for tax, interest and penalty citing a “math” error on your return.  However, more often than not, it appears it’s the IRS who is in error.  A recent Treasury Inspector General for Tax Administration report found that IRS correspondence audit are often "inaccurate and overstated”.  So don’t just assume that IRS notices are correct.

Selected for audit?

We suggest proceeding with caution when responding to the IRS and encourage you to contact us if you receive a notice.  Given that many IRS notices are in error, it is best to thoroughly investigate the validity of the IRS claims. Never delay in responding to the IRS; correspondence audits do not provide for the same administrative appeals available in a full-blown audit unless you respond in a timely manner.  We have a wealth of experience representing individuals and small business owners with tax compliance issues so consider letting us guide you through the audit process. Please contact our office if you have any questions or would like to discuss further.