Your chances of getting audited are slim, but the investigations do happen.
According to Jeremy Kisner, president of Surevest Wealth Management, there is an overall 1% chance of getting audited. However, he says for those bringing home more than $200,000 in 2013, their chances jump to 3.26% and 10.85% for those making more than a $1 million
“There are very few totally random audits out there,” says Kisner. “What computers are looking for in general are a number of red flags.” For example, someone making $60,000 a year with $30,000 in charitable donation claims might raise some eyebrows at the IRS. A small business owner writing off 100% of his car as a business expense can also lead to an audit.
“They are looking for outliers outside the norm,” says Kisner. “The IRS needs to justify their existence so they are looking for the big fish.”
Everyone dreads a letter from the IRS. While the first reaction may be to panic, often these audits can be handled easily without too much trouble, experts say--granted you were honest on with your return.
Here are the steps expert suggest taking if you receive a letter from the IRS:
Figure Out What the IRS Wants
A letter from the IRS doesn’t always mean you are being audited, sometimes the agency is looking for more information or clarification.
If you do get an audit letter, the first thing is to determine what part of your tax return is being audited, says Tom Kosinski, a tax director at Ostrow Reisin Berk & Abrams. Often, IRS auditors will have questions on a portion of the tax return--not the entire thing.
“You have to start with the question: ‘why am I getting audited?’” says Kosinski. “Many times you are getting selected because the IRS doesn’t have a lot of information about you.”
With most tax payers, the IRS has access to all their information, like their total wages and how much mortgage interest they paid. However, returns filed by self-employed people and the wealthy tend to have a lot more self-reported items that the IRS may question.
Kosinski says tax payers facing an audit have to review their return to make sure everything is accurate. He also recommends only providing the information the IRS specifically asks for to avoid broadening the scope of the audit.
Once you know what the IRS is looking for, the next step is to getting documentation that proves your claims.
For example, if you are being audited because you wrote off 100% of your car usage as a business expense, get your mileage log and other evidence that the car was used only for business purposes all in one place.
If you haven’t saved any documentation or proof that your claim or claims are valid, Kosinski says there are some methods allowed during an audit to estimate items on a past return. The best method, he says, is to get support from third parties that can come up with a reasonable way to verify the accuracy of a claim. For instance, if you are being audited over donations made in 2011 and don’t have any evidence, reach out to the charities to provide some support.
Another method Kosinski suggests is to come up with a sample of what your business or personal lifestyle was like during the time of return being audited. But be warned: This may not be a fool proof plan; a sample may bring additional questions because your lifestyle may have changed from one year to the next.
The IRS has up to three years to audit your tax return so that just-received letter could be from your 2011 taxes, which is why you should keep tax documents for at least three years.
Be Polite, Courteous and Quick with Responses
Ignorance is bliss, but in the case of an IRS audit, ignoring the letter could make the situation worse. The IRS will give you a certain deadline to respond, make sure to meet it.
“If you don’t respond, you are starting off on the wrong foot,” says Kisner. “You don’t want to alienate the auditor. You want to treat him or her with respect just like a police officer.” If you don’t feel comfortable doing the talking, experts say to have your accountant or tax preparer handle the discussions for you, but avoid creating a combative tone to the audit.