With the stress of filing your tax return now ideally in the rearview mirror — or kicked down the extension road to October 17 — many individuals have shifted to worrying about their chances of being audited.
The numbers suggest it’s unlikely. Still, a host of pandemic-driven tax changes have created several potential minefields, and the sheer complexity of the tax code offers plenty of room for a taxpayer to make mathematical or clerical errors — and to worry.
“People are almost always scared about being audited,” said Christopher Smith, the founding tax partner at Brandywine Oak Private Tax Advisory, a financial consulting firm in Kennett Square, Pennsylvania. “To the point where some people are scared to take things that they legally could.”
Last year, just 4.5 out of every 1,000 individuals who earned between $200,000 and $1 million — less than half a percent — were audited,
Formal Internal Revenue Service scrutiny has been declining for a decade due to budget cuts, computer systems that date back to the Kennedy administration and declining ranks of enforcement staffers. In the more than two years since the pandemic emerged, the crisis-stricken agency has struggled to handle mammoth processing backlogs, trillions of dollars in government relief for individuals and businesses and a tsunami of phone calls from frustrated taxpayers —
In general, the IRS goes after earners with the highest and lowest incomes. While the agency generally has three years from the date a return is filed to pore over it with a magnifying glass, it can go back six years if it suspects you underreported big sums.
Who gets audited
Just over five of every 100 people making at least $10 million in 2018, or 5.3%, were audited in 2018,
The audit rate for those making between $1 million and $5 million dropped to 0.6% in 2018. It was 8.2% in 2010.
Those making at least $100,000 but under $1 million faced a 0.1% to 0.2% chance of being scrutinized in 2018. The rate ranged from 0.8% to 8.2% in 2010.
By contrast, people earning less than $25,000 are five times more likely to get audited compared to everyone else, according to TRAC. That’s in large part due to the
The IRS calls audits “
Here are three big audit triggers this filing season that have sprung up since COVID-19 altered work and life, according to accountants and financial advisors.
Pandemic business relief
Since the pandemic emerged in early 2020, the federal government has showered loans, grants and tax credits on struggling Americans and businesses. All of those payments have the potential to gum up a return and delay any refunds or trigger an audit.
Recipients of the the Small Business Administration’s roughly $800 billion in Paycheck Protection Loans to help businesses stay afloat and keep workers employed don’t have to report the money as taxable income on their federal returns if they’re not forgiven.
If the loans are forgiven, they still don’t count as taxable income — but the clean slate must be reported in a
With the White House’s proposed Build Back Better legislation and its impact on taxes in limbo, advisors have time to implement key tax planning techniques.
Working remotely from a home office
Before the tax code overhaul in 2017, anybody who worked from home could potentially claim the
Scores who lost their jobs can potentially claim the benefit. But the requirements are prickly. IRS rules state that you must use a part of your home “exclusively and regularly for conducting business.” Doing so can allow you to deduct a percentage of your mortgage interest, insurance, utilities, repairs and depreciation for the square footage of the work area. Plunking your laptop on the dining room table or next to a toddler’s playpen doesn’t count. Smith said that the home office deduction was one of the biggest triggers.
Large jumps in income
If you own a business that went gangbusters despite the pandemic — and yes, they exist — the spike in profits can be a red flag. “What I’ve seen is that dramatic jumps in income or expenses can tend to throw audits,” said Clark Kendall, the president and CEO of Kendall Capital, an independent financial advisor firm in Rockville, Maryland. “For some people, it’s just a part of doing business. For others, they have sleepless nights.”
The IRS is always on the lookout for cash-intensive businesses that can underreport income, such as restaurants and beauty salons. Those enterprises, some of them PPP recipients, tend to be run as private entities, like an S corporation or a limited liability company.
Even if they dislike digital assets, wealth planners have a fiduciary duty to understand their confusing and murky tax treatment.
But not just mom-and-pop businesses can fall under the microscope. In late 2020, a senior IRS official said the agency would
Samuel Landis, a tax lawyer in Beverly Hills, California, said that the biggest audit trigger on a return is expenses that are a high proportion of income. Just how high is an IRS secret: Landis said that the agency typically takes a sample of 10,000 returns filed by taxpayers within a particular profession to determine a risk ratio. “If you’re outside the ratio,” he said, “you’re pulled for an audit.”
