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How The IRS Selects Its Candidates For An Audit

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ODDS

It seems that one of the things Americans fear the most, is an IRS audit, and understandably so.  Despite the universal fear, audit numbers are down to an all-time low. According to AccountingToday, More than 150,000,000 Americans filed taxes in 2017, and the IRS makes their audit statistics available.

FORM 1040 PAYERSODDSBUSINESS/SPECIALTY TAX PAYERODDS
International Taxpayers1/19Large Corporations (Form 1120; assets over $ 5 billion)1/3
Gross income before deductions of more than $1 million 1/23Estate Tax Returns1/12
Sole proprietors with gross income before deductions between $100,000 and $200,000 1/48Large Corporations (Form 1120; assets between $10 million & $5 billion)1/23
Sole proprietors with a gross income between $200,000 & $ 1 million1/64Excise tax Returns1/72
Self-employed with income under $25,000 who claim EITC1/72Gift Tax Returns1/130
  Small Corporations (Forms 1120, not 1120-S)1/146
FORM 1040 TAXPAYER TYPESODDSCORPORATE PARTNERSHIP AUDIT RATEODDS
All payers1/161All payers1/224
Farmers1/228Partnership Returns (Forms 1065)1/260
Wage earners who make less than $200,000 per year and do not claim EITC (65% of all taxpayers)1/364Estate & Trust Income Tax returns (Forms 1041)1/971
  Employment Tax Returns (Forms 940 & 941)1/568
  S Corporation Returns (Forms 1120-S)1/358

As a rule the IRS audits the traditionally non-compliant taxpayers:

  1. Small Business Payers
  2. International Payers
  3. High-Wealth Payers
  4. Earned Income Tax Credit fraud schemes.

Audits are not the only way the IRS scrutinize tax returns. Some algorithms employed result in automated checks on filings.  The automated underreporter program (IRS CP2000) matches income and IRS information, ad red flag discrepancies, for which explanations requests are automatically generated.  This system outnumbers audits by 3.1 to 1.

The budgetary constraints have even impacted the automated checks. Despite these IRS CP2000’s not being audited, it enhances the IRS’s ability to challenge taxpayer’s returns. When combined (rates for CP2000 matching and returns challenge), the odds of the IRS challenges you come to 1/35 rather than the audit odds of 1/161!

What’s The Damage?

It is costly to be audited.  More than 90% of all taxpayers (individuals) who undergo and IRS audit, will face an additional payment; for an old fashioned field audit, this extra payment – and shock to the system – will come up at an average of $21,918.  The same average for a “mail audit” will be less, and averages out at $6,014. 

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A CP2000 is also not cheap.  During 2017 the IRS collected and average of $2,033 per notice issued, for a whopping extra revenue of $6.7 billion.  What’s more, over and above the additional taxes payable, the IRS also charge penalties (for inaccuracy) of 20% on top of the same.

What Can I Do to Beat The ODDS?

Sometimes the odds are the odds, especially for higher-wealth taxpayers and international taxpayers whom the IRS believes returns likely contain errors and omissions.  For the rest of us, full disclosure is the way to go.  Report all wage and income documents; never omit any documentation. 

When hiring a tax professional, they would do some due diligence by investigating your tax returns for previous years and request a post-filing review during the summer before the CP2000s go out in November.  Any unreported income found and disclosed with an amended return, can help you to avoid accuracy penalties.

IRS Debt Resolution

For those of you who do receive a CP2000 notice, it might be the right time to visit your local tax professional.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intended for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services.  This article cannot serve as a substitute for such professional services or advice.  Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation.  This article is subject to change at any time and for any reason.

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Fulton Abraham Sanchez, CPA

Fulton Abraham Sánchez, CPA is a Certified Public Accountant, specialized in Tax Planning for Real Estate, Hedge/Equity Funds, Fintech, Crypto, Expats, IRS Debt Resolution and Offshore Strategies. You can email him to fa@fascpaconsultants.com and follow us on Facebook : FAS CPA & Consultants.

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