With the tax-filing season behind us all, many folks just tend to ignore their returns for another year. But many others wonder (and worry) about the chances for an audit. Will your return be audited?
Nobody can say for sure. But it's certain that the IRS has stepped up its enforcement staff in an effort to collect more tax dollars.
A recent IRS study estimates that the difference between the amount taxpayers owe and the amount they actually pay (known as the "tax gap") is between $312 billion to $353 billion per year. That's a staggering amount, and the IRS is aiming to reduce it.
According to IRS statistics, the number of individual audits has increased from 618,000 in 2000 to a little more than 1 million in 2004. That's an increase of more than 60% in just a few short years, and it equates to a 1 in 129 chance of audit based upon total returns filed. If your income surpasses the $100,000 threshold, your audit chances increase to about 1 in 68. If you're self-employed filing a Schedule C, your audit chances increase yet again. As you might imagine, those taxpayers earning virtually all of their income via W-2 forms, with no unusual deductions or large losses on their returns, are much less likely to receive an audit notice.
In addition to full-scale audits, the IRS sends out millions of "correction notices" each year. These notices are computer-generated, resulting from a discrepancy between information reported to the IRS and the information reported on your tax return. While these correction letters are less imposing than an audit, they could still cost you additional taxes.
The IRS has identifiable audit objectives, especially self-employed taxpayers and wealthy taxpayers with big losses on their tax returns. Likely targets also include worker-classification issues (employees vs. independent contractors), unscrupulous tax preparers, and their clients, including failure to report all sources of income in general. The IRS is working diligently to "target" tax returns that will return the greatest additional taxes to the treasury relative to the audit resources employed.
Should you be terrified that your return might be selected for audit? Certainly not. An accurately prepared return is the first line of defense, and well-maintained substantiation records are the ammunition for that defense. Audit selection doesn't necessarily mean that additional taxes will follow. That's especially true if you receive one of the IRS's computer-generated "correction notices". There are many defensible responses to an IRS audit or notice.
Don't stress about an audit. Instead, make sure that you maintain sufficient records and work hard to prepare an impeccable and completely defensible return. Then, if the IRS questions you, you'll have all of the ammunition to turn the audit into nothing more than a nuisance -- without costing yourself additional tax dollars, penalties, or interest.
When he's not dealing with tax issues, Fool contributor Roy Lewis is a motivational speaker who lives in a trailer down by the river. He understands that The Motley Fool is all aboutinvestors writing for investors. You can take a look at thestocks he owns, as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.