"I won't get audited because (insert common audit myth here)."
I've been in the tax biz for more than two decades, and I've heard many ways to complete that sentence. I'm regularly amazed by what some people say -- and sadly, believe -- when it comes to the IRS and the dreaded audit.
Make no mistake: There will be more audits on the horizon. The IRS has been adding staff since 2005, and it's ramping up to recoup some of the audit money lost when it became the "kinder, gentler IRS." In fact, my personal practice has represented more audit clients in the past year than it had in the prior four years combined. Believe me when I tell you that the IRS is out there on the prowl.
While IRS audits have been around for many years, there are still a number of misconceptions about what triggers an audit, or how to avoid one. Here are the top five audit myths that can be used to complete the sentence found at the top of this article.
"... I received my refund."
Just because you received your refund check, don't assume that the IRS has reviewed your return and has given its blessing. That's true whether you file electronically or with a paper return. Sure, the IRS checks for obvious errors and suspicious deductions, and it may hold up your refund check while it investigates. But simply receiving a refund doesn't mean that you're home free.
In fact, audit determination is made long after the refund check is issued. After your return has been filed and you've received your refund, your tax return goes through another computer check, comparing it to a computer model. The return then receives a DIF (Discrimination Information Function) score.
The IRS calculates the DIF score with a very closely guarded formula. Returns with high DIF scores are then pulled and reviewed by skilled and experienced IRS agents to determine which ones have the greatest potential for yielding additional taxes, interest, and penalties.
Generally, the IRS has three years from the time a return is filed to perform an audit. While the IRS likes to begin the audit process three to four months after the tax return filing deadline, many returns aren't audited until 18 or even 24 months later.
"... I'm lucky."
True, if your income is less than $25,000, you have less than a 1% chance for audit. Even if your income is greater than $100,000, your chance for an audit is still less than 2%. But that doesn't mean returns are randomly selected for audits. As noted above, the return is reviewed and scored by a computer and then sent to an examiner.
Regardless of your income level or your luck, if you have questionable items on your tax return, you'll have a greater chance of being audited. Putting false numbers on your tax return and hoping to win the "audit lottery" is more like playing "audit roulette."
"... I don't file until after audit 'testing' season."
This has been an ongoing myth for a number of years, and it's still hotly debated by tax professionals. Here's the strategy: File an extension of time to submit your return, and don't actually file it until Oct. 15.
Whenever you file, your return will still be run through the computer and given a DIF score. If your score exceeds what's considered the cutoff point, it has a high audit potential. It's true that the DIF score "norms" might fluctuate as more returns are put into the system, but it doesn't mean that a return filed later will pass muster simply because it came in at the tail end of the filing season. Heck, the audit selection process isn't even started until the end of June, more than two months after the usual April 15 filing deadline.
Again, many tax pros will tell you that a return filed in October will be less likely to get audited than a return filed in March or April. I can only tell you that after almost 28 years in practice, I've seen returns audited regardless of the ultimate filing date. Do you want to go through the hassle (and expense, if you're using a tax pro) of filing two extensions in order to use the Oct. 15 deadline? It certainly won't hurt, but I'm not sure that it'll help.
"... I deal in cash only, and they can't audit cash."
This is perhaps the silliest and most reckless statement of them all. With the advent of computers, "Big Brother" knows more about you than you might be aware. Don't you think that an IRS eyebrow might be raised if you live in a $1 million house with reported income of about $30,000 per year?
Many of the folks who deal in unreported cash end up putting that money right into their bank accounts. Can you get any dumber than that? And how about those folks who use all of that cash to purchase a boat, motor home, airplane, or other expensive toy? The IRS has a form that a seller must complete if somebody pays $10,000 or more in cash for stuff like that.
In addition, the IRS has techniques that allow its auditors to "look through" your reported income and arrive at your estimated (and many times confirmed) real economic income. Although the so-called "lifestyle" audits have been placed on the back burner, the IRS and Congress realize that unreported income remains one of the biggest problems facing the tax system, and they're making plans to do something about it.
Finally, deliberately understating your income is nothing less than tax evasion, and the penalties for this crime are quite severe. Do the names Al Capone, Pete Rose, or Leona Helmsley ring any bells?
"... I have an accountant who knows what you can get away with."
Taking advantage of all of the legal deductions available to you isn't the problem here. It seems that some tax professionals (and I use the term loosely here) pop up every tax-filing season and urge their clients to pump up their itemized deductions to the "average" deductions computed and released by the IRS. In fact, this has become such a problem that the IRS has a special task force (headed by the Criminal Investigation Division ... the folks with the badges and guns) to ferret out dishonest tax preparers.
However, these averages vary by state and region, and they aren't necessarily the only criteria used to compute the DIF score. Any tax preparer who urges you to claim deductions you don't actually have, simply because you're under the "average," isn't doing you any favors. In fact, most of these so-called professionals are long gone when the IRS taps you on the shoulder and asks you to provide the documents to support your deductions.
Don't believe any of these popular audit myths. Take advantage of the legal loopholes, report all of your income, and take every allowable deduction. Then stop right there.
When he's not dealing with tax issues, Roy Lewis is a motivational speaker who lives in a trailer down by the river. He understands that The Motley Fool is all about investors writing for investors . You can take a look at the stocks 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.