In 1989, the IRS was ordered to shift its primary objective from collecting taxes to a greater focus on taxpayers’ rights. As a result, the number of annual audits steadily dropped over the years. During the first year of the restructuring of the government agency, 1 in 79 tax returns were audited. By 2003, this statistic had decreased to 1 in 150. Although fewer taxpayers are being sent audit notices today, there are still IRS red flags that may increase the chances of being audited.
Being Rich
In recent years, the IRS has increased its focus on rich taxpayers. Those who earned less than $200,000 in fiscal year 2013 had a 0.88 percent chance of being audited. In contrast taxpayers who earned between $200,000 and $1 million has a 3.26 risk of being audited. Among those who made over $1 million in 2013, 11 percent were subjected to an IRS audit.
The Big DIF
One of the ways the IRS selects tax returns for audit is by using its computer scoring system known as Discriminant Information Function, or DIF. Although the exact formula for determining which returns are more likely to contain IRS red flags is a highly guarded secret, DIF examines typical deductions, credits, and exemptions that would normally be taken for each income bracket.
Comparing Deductions
Tax professionals believe one of the keys to avoiding IRS red flags lies in a tax return’s deduction amounts. By looking at average deduction amounts, the IRS may spot inconsistencies such as a taxpayer who has a low income, but claims a large deduction for mortgage interest. Other potential deduction inconsistencies may lie in the following:
• Income other than basic wages
• Unreported income
• Home-based businesses, especially when in addition to salary income
• Home office deductions
• Non-charitable donations
• Large deductions for business meals and entertainment
• Excessive business vehicle usage
• Losses from activities that appear to more likely be a hobby than a business
• Large casualty losses
Claiming Deductions
Although the thought of an IRS audit may be intimidating, taxpayers should continue to claim legitimate deductions. Being questioned by the IRS does not automatically mean the taxpayer will owe taxes. Maintaining accurate records will make the relatively unlikely event of an audit much smoother. Finally, even if the IRS concludes that taxes are owed, the taxpayer has the right to contest an audit.
Seek Representation
If efforts toward preventing an IRS audit fail, taxpayers are advised to seek out professional help. Having qualified IRS audit representation may save time and frustration. As a seasoned CPA, Gary M. Kaplan is available to offer professional guidance and representation to taxpayers in Florida, New York, Washington, D.C., Utah, and Maryland. Clients can always expect to receive personalized, knowledgeable, friendly service when interacting with the highly skilled team at Mr. Kaplan’s firm.
