Most taxpayers are safe from audits, but high-risk or high-income occupations, self-employed individuals with significant business deductions, and those who enter information that raises flags are more likely to be audited. To avoid audits, accurately report income and keep deductions within acceptable limits, avoid disreputable occupations, and check for math errors and personal information mistakes. The IRS uses a secret formula called the Discriminant Function System to determine who to audit.
Under the current IRS system, few taxpayers are completely safe from being audited, but more than 99% manage to fly under the IRS radar each year. Of the very small percentage that end up being audited, most are in high-risk or high-income occupations or are self-employed with significant business deductions listed on their returns. Others are randomly selected for quality control purposes or because they entered information that raised flags according to a secret IRS formula. Your chances of being audited as an average citizen paying an average amount of federal taxes are still pretty slim, at least in theory.
One thing you can do to avoid being audited is to avoid occupations that require a lot of money, such as auto repair, waiting tables, gaming, professional entertainment, and anything in the hospitality trades. Taxpayers who receive significant amounts of tips or cash tips are required to report this income to the IRS, but in reality many people do not report the cash income on their tax forms and keep the rest. If you work in an industry where cash payments and tips are part of your income, you must keep accurate records and report this income to avoid being audited. If a waiter who works in Las Vegas, Nevada, for example, only reports $12,000 of income on her taxes, the IRS may wonder if he is understating his tip income.
Another way to avoid being audited is to check your math before you submit your tax return. The IRS computer system can correct minor errors, but a tax return filled with numerous math errors will attract unwanted attention, especially if those errors routinely favor the taxpayer. Mistakes in personal information, such as addresses or social security numbers, can also increase your chances of being audited. Their goal is to make your own tax return look as inconspicuous as the rest of the forms sitting on an IRS agent’s desk. E-filed returns are supposed to be included in the “audit lottery,” but it’s often an out of sight, out of mind case.
The IRS tends to audit taxpayers with a greater opportunity to underreport income or claim unauthorized business expenses. That’s why an excessive number of taxpayers being audited are self-employed or involved in businesses that the IRS considers ripe for financial abuse. Self-employed individuals must retain enough money each year to meet their tax obligations, but they are also entitled to claim a number of legal business expenses to offset those obligations. The IRS is aware of the temptation to report personal expenses as business expenses, so it’s not unusual for a self-employed person to find themselves audited after filing a tax form with questionable deductions.
Your chances of being audited also increase if you work in disreputable occupations. Owners of telemarketing companies, direct marketing agencies, and personal loan companies may find themselves audited more frequently than the general population. These types of businesses earn significant amounts of revenue through high-sales tactics and abuse of consumers, making them interesting targets for IRS agents looking to uncover hidden income. If you want to avoid being audited, avoid employment in gray area occupations.
The IRS uses a secret formula to determine who can be audited during the three-year window of opportunity after a questionable tax return is filed. Called the Discriminant Function System (DFS), this program compares the numbers reported on a particular tax form against a set of standards established by years of demographic research. If a taxpayer with a wife and four children lives in Beverly Hills, California, but only reports $20,000 in total income, the DFS program will likely flag the return as suspect since the income does not match the demographics of the city. Similarly, someone who reports a significant amount of charitable giving compared to her modest income could also find herself audited.
In short, the trick to avoiding being audited is to report your income as accurately as possible and keep your deductions within acceptable limits. Avoid raising flags with the IRS and you may avoid being audited—unless, of course, you win the random “audit lottery” and find new and exciting ways to work up a sweat.
Smart Asset.
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