According to data recently revealed by USA Today, the rate at which the IRS conducts audits of individual taxpayers sunk to a ten-year low as of 2014. Now at a measly .86%, the relatively few number of audits conducted presently is welcome news to taxpayers, but does it mean that there’s no reason for anyone to be concerned about finding themselves on the receiving end of an audit notice? Not at all. For one thing, the audit rate may be low, but it is certainly not zero, and never will be. For another, despite the lower audit rate, the behaviors of those taxpayers which make them likelier candidates for audit selection remain the principal determinants for the IRS in who ultimately comes to be under its thumb, so it’s worth a closer look at some of those so that you remain aware of the red flags that can prompt Uncle Sam to come calling.
High Income. Although the overall audit rate is under 1 percent, it is higher for those folks who make at least $200,000 per year, and higher still for those who earn at least $1 million annually – just over 10 percent. Admittedly, there isn’t much you can do (or would likely want to do) about the increased audit risk that comes with making a lot of money, but if you do find yourself making a fair sum, it is a good idea to arrange your tax-related affairs in such a way that you expect to be audited at some point. Hopefully, if you have a good tax preparer, he or she is taking good care of you and doing the things on your behalf necessary to ensure you will be bulletproof at tax time; if you are not sure that such is the case, don’t be shy to mention that you are aware that higher incomes receive more audit attention, and ask if there is anything more you should be doing to ensure you will emerge unscathed should a dreaded audit notice appear.
Large Charitable Deductions. One of the ways in which people seek to lower their anticipated tax bills is by making sizable charitable deductions. You have to be careful about this, however, because if the dollar amount of the total deductions you claim in a given year is high in comparison to the amount of money you earned, that apparent disparity can stick out like a sore thumb to the IRS. While there can be a number of good explanations as to why you happened to have a high value in donations one year, just remember that the mere fact you had them may pique the curiosity of the government, so you should maintain excellent records to back up the giving that you did. If the total amount of the deductions you’re claiming for noncash donations is more than $500 for the year, you have to complete Form 8283, so while you want to be sure you’re doing that, be especially mindful of the value you’re declaring on behalf of the donated goods; remember that despite whatever personal value you see them as having, or whatever you originally paid for them, the value of those goods as donated items has to do only with their worth in their current condition, in the present-day market. If you paid $500 for a suit several years ago, but that suit will sell at the local thrift store for around $75, the value you should be claiming should much closer to the $75.
Self-employed. The self-employed remain juicy targets for the IRS because of the substantial number of deductions normally claimed by a small businessperson. If you are self-employed, while it is nice to hear of declining audit rates, you cannot let your guard down, because whatever resources the IRS does have to apply to audits will be used to audit your professional demographic at a higher-than-average rate. The IRS established long ago that the self-employed are especially guilty of underreporting their income, while being far too generous with the deductions claimed, so they will always have the self-employed in their crosshairs. Again, you will always be better off, from the standpoint of remaining as audit-proof as possible, if your deductions look “income-appropriate;” high deductions for meals and travel come with enhanced risk, to be sure. Whatever you claim, make sure to keep excellent records – don’t allow yourself to get lazy about that. Other deductions that tend to register prominently on the IRS’s radar include the business use of a vehicle, as well as that claimed for a home office. As a matter of fact, some tax preparers will actually discourage clients from claiming the home office deduction, because it’s considered such a bright red flag by the IRS. That doesn’t mean you should not claim it if it legitimately applies…but understand, up front, how it raises your profile.
In the end, the news that the IRS is struggling to maintain the staff and resources necessary to perform audits is surely welcome to just about all of us. However, it would be a mistake to see yourself as having no chance of being audited, particularly if your personal profile reflects one or more of the higher-risk characteristics noted here. My advice is that you change nothing in the way of what has (hopefully) been a long, solid history of diligent recordkeeping and sound tax preparation, and simply treat the present reality of fewer audits as a bonus to all of your hard work at keeping your financial ducks in a row.
The information contained here is for general information purposes only. The Financial Writer blog and Bob Yetman disclaim responsibility for any liability or loss incurred as a consequence of the use or application, either directly or indirectly, of any information presented herein. Nothing contained in this article, or any other article featured at this blog, should be construed as a solicitation or recommendation to engage in any financial transaction. You should seek the advice of a qualified professional before making any changes to your personal financial profile.