What’s Your Chance of an IRS Audit?

The IRS publishes statistics regarding the percentage of returns that have been examined by type of return. Not surprisingly, some taxpayers have a greater chance of being audited than others according to the latest statistics. Let’s take a look at some stats:

The majority of audits, 74.8%, were conducted via correspondence, and the remaining 25.2% were conducted in the field.

Overall audit rate: The overall audit rate is .5%, but the audit rate of individual returns is .6%.

Corporate audit rates:

.9% for all corporate returns, excluding s-corporations

8.1% for large corporations with assets of $10M or more

.2% for s-corp returns

Individual audit rates:

2.4% for returns with business income and gross receipts of $100,000 to $200,000

3.2% for returns with positive income of $1M or more

.2% for returns with income lower than $200,000, no Earned Income Tax Credit, no business income or rental income.

If you read the footnotes of the statistics, it appears that 37% of individual returns that were selected for examination were due to a taxpayer claiming the Earned Income Tax Credit (EITC). Also, the statistics do not include several million CP2000 notices that are sent to taxpayers each year when there is a mismatch between what is reported on their tax return and what is reported to the IRS. If those notices were included, then the audit rate would be much higher.

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What Should You Do When You Receive a Notice from the IRS?

Did you notice that the title states “when” and not “if” you receive a notice? The volume of notices received from the IRS, along with those from the states, has steadily increased over the years, which means that the odds of you receiving a notice are pretty high. What are some of the steps you should take?

Don’t ignore the notice: This may sound basic, but do not ignore the notice. Usually, there is a deadline for your response, and if you do not respond then the issue may get worse and more complicated. If you do not understand the notice or have an accountant, then quickly send the notice to him/her.

Make sure it belongs to you: Sometimes, the notice may not even be yours. Sometimes the IRS or the states have an old address on file, which happens to now be yours. If the notice does not belong to you then ask the post office to return to sender. That is an easy fix, but not as common as one could hope for.

Time period and type of tax: The notice should show what periods and type of tax the notice relates to. Common notices are for Form 1040 (individual taxes), Form 941 (payroll taxes), and various states’ sales and payroll taxes.

What is the notice asking for: A commonly received notice from New Jersey and New York is one requesting additional information to process a refund after filing your tax return. You should provide the information requested and send a cover letter via certified mail. Other common notices state that there was additional income that was not reported, such as stock sales or pension income, and now there is a proposed change to your tax return. The scariest notices are levy notices or lien notices, which are supposed to come after no action has been taken on previous notices.

Compare the notice to your records: In many cases you want to verify the validity of the notice and should compare the information in the notice to your own records. It is possible that the notice may be incorrect or only partly correct.

Always respond timely: Make sure to always adhere to the timeline of the notice and to send any correspondence by certified mail as timely proof of a response. Even though you may respond timely this does not mean that the IRS or states will respond timely to you, and you may have to be patient.

As a warning, the IRS will never email you nor will they ask you to purchase prepaid gift cards from CVS to provide to them. Also, they will not threaten to deport you or throw you in jail. If you did something criminal then they will just show up at your house at 6 AM or possibly 5 AM, and I am sure that you already know why they are there.

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The IRS Called Me Yesterday

That’s not strange because as a CPA I speak to the IRS quite often. However, they called my cell phone and left a prerecorded message about tax fraud. It was a scam of course, and I am posting this to warn you that the IRS does not call taxpayers initially without sending a notice, nor do they threaten you with an arrest. If you have received a phone call like this and are not sure if it is legitimate, then please contact our office.

Here is the message:

“Hello, this call is officially a final notice from IRS, Internal Revenue Service. The reason of this call is to inform you that IRS is filing a lawsuit on your name because you had tried to do a fraud with the IRS, Internal Revenue Service, and we are taking a legal action and we are issuing an arrest warrant on your name. To get more information regarding this case just call us back on our department number 202xxxxxxx. I will repeat it 202xxxxxxx. Thank you.”

By the way, the IRS will not ask you for credit card numbers over the phone or ask you to purchase a prepaid debit card.

I Received a Notice from the IRS – Now What?!

If you receive a letter in the mail from the IRS, the first thing you should do is open it! It might not be as bad as you think. The most common notice I see is that a client forgot to include interest, dividends, or wages from a W-2 on their income tax return and now they owe additional taxes, interest, and penalties.

Just because you receive a notice that you owe money doesn’t mean the notice is correct. You want to see why there is an increase, and compare the figures in the letter to your tax return. Then you want to see what the proposed changes are. I have seen notices that have actually showed incorrect W-2 wages.

Usually you have 30 days to respond to the notice before additional interest and penalties will be assessed. There are several options to take at this point.

The first option, if the notice is correct and the additional penalties and interest are very insignificant, should be to pay the amount due as soon as possible. If the notice is correct and you have a valid reason for not including a portion of income, you should then include payment of the taxes and interest on those taxes only. Additionally, you will need to respond to the notice to state why the penalties should be removed. The IRS will remove penalties if you have a justifiable reason. As a caveat, if the penalties are not removed then you will owe not only penalties, but possible interest on the penalties as well. The cost/benefit has to be weighed carefully. If the notice is completely wrong, then you should not send any payment, but include an explanation in your written response to the IRS, along with any supporting documents to show why you do not owe additional taxes, interest, and penalties.

As you can see there are several options when receiving a notice from the IRS or one of the state taxing authorities. Do not hesitate to contact our office if you receive a notice. We can clearly explain it to you and guide you through the next step to take.

An Overview of IRS Audits

There are different types of IRS audits. The first and least complex is the correspondence audit, next is the office audit, and lastly and most complex, the field examination. I highly recommend to anyone who receives a letter from the IRS, or even the State of NJ, to contact their tax advisor as soon as possible.

The correspondence audit is the most commonly used audit of all three types of audits. It starts with a letter issued from the IRS stating that a change has been made to your tax return, such as for investment income that you failed to report. Assuming in this case the IRS is correct, you will need to submit the additional tax assessed on the unreported income, along with interest to the IRS. If the IRS is not correct and you disagree then you will need to provide an explanation to prove that you do not owe additional taxes. Sometimes the notice is partly right, and the best course of action may be to file an amended return or complete the appropriate forms.

Since correspondence audits are very cost effective for the IRS, they also send letters for specific deductions, such as charitable contributions, to request substantiation for your deductions. This is why it is extremely important to keep all receipts for your deductions, because without any proof that you made donations, your deduction will be disallowed and additional taxes and interest will be assessed.

The next audit, the office examination, takes place at one of the field offices of the IRS by a local agent. Although more complex than a correspondence audit, the agent usually focuses on a select number of items. It is very important to be very prepared for this type of audit because it can lead to the agent broadening the scope of the audit.

Lastly, and most in-depth, is the field examination. This involves an IRS agent visiting your place of business or possibly your home. The agent requests much more information and asks a lot more questions. Again, it is very important to be well-prepared for this audit. It is also crucial to communicate with and work closely with your tax advisor.

After completion of an audit, there can be several outcomes. The first is an assessment of additional taxes, interest, and/or penalties, the second is no change to your tax liability, and third you may actually be due a refund (not likely, but that would be a great outcome)!