Every tax season, business owners and individuals file their returns hoping for the best but fearing the worst – an audit. It’s something no one wants to go through, and the consequences if an audit ends badly could be disastrous.
However, while these feelings of unease when filling out your tax return are completely normal, the truth is that the IRS audits a small percentage of businesses and individuals each year.
The IRS audited just 0.83 percent of total tax returns from individuals in 2014, which is down from 1.03 percent in 2012. The government agency releases basic information on the criteria it uses for selecting returns for audits, but the specifics of the process are mostly unknown to the general public. The IRS uses a computer-generated score, known as the Discriminant Information Function score, which compares current tax filings with those from the same and similarly situated individuals or businesses from previous years.
While we can never predict which filings the IRS will audit, there are a few characteristics that cause the agency to take notice. Typically, the IRS will target outliers. For instance, if your income or deductions are not within the expected range for your career or business, your chances for an audit increase. Also, an individual’s likelihood of an IRS audit rises based on how high the total adjusted gross income number is. In fact, the IRS reviews less than 1 percent of returns from Americans reporting less than $200,000 in adjusted gross income per year. Having an all-cash business, home office or excessive charitable donations all increase your chances of being audited.
Factors increasing the likelihood for an audit change from year to year, but there are a few worth noting as we plow through the 2015 tax season. We expect the IRS will focus on individuals and businesses with offshore bank accounts. With new reporting obligations by offshore banks to report U.S. taxpayers’ accounts, it is even more important to disclose these accounts and file proper Foreign Bank and Financial Accounts (FBARs), which are not part of the tax return. In somewhat of a Catch 22, filing the FBARs and disclosing the offshore accounts may bring additional scrutiny.
While less than 1 percent of returns end up being audited, it’s certainly prudent to be aware of some of the red flags that the IRS is screening for.
The graphic below outlines eight things the IRS usually scrutinizes when deciding who to audit. If you are one of the unlucky few who goes through an audit, check out this blog post on how to survive it.