Why they want to Audit you

It is ABSOLUTELY no fun to see that envelope from the IRS in your mail, and when you open it to find they have decided to audit your return, it’s even less fun!

So what causes some taxpayers to be audited while others never seem to have any contact with the IRS?  As with many things these days, computers and their programming look at data that lies “outside” of an average, and then, flags a return based on that data.  Let’s look at a few of the most common ones and how they impact W-2 employees…

  • The biggest one, by far, is failing to report ALL taxable income.  Many times, of course, this is a simple mistake on the part of the taxpayer – maybe they forgot a bonus, or some small dividend, or even a part-time job or contract they only had for a month or two.  Nevertheless, the tax law is simple:  ALL income is taxable and ALL income is reported to the IRS both from the taxpayer and the entity that pays the taxpayer.  Somewhere in the bowels of the IRS, those two numbers are matched up and when they don’t match, guess what?  It either flags the return for an audit or the IRS simply sends you a bill for the untaxed income.  
  • Taking an early payout from a 401(k) has always been a red flag for the IRS, but with so many Americans having to break into retirement savings in the last year, the simple mistakes that are usually made – not claiming the money, not paying taxes or penalties on the funds, and so on – are a real challenge for a lot of people.  The IRS’s own studies have shown that as many as 40% of people who take a payout from their 401(k) fail to properly document the income and pay the taxes, so they are on firm ground when they look to review the returns of anyone who has taken money from their retirement account.  
  • Ironically, even depositing large amounts of currency can trigger an audit.  The IRS has long required banks, car dealers, and even pawn shops to report any large cash transactions (over $10,000), but that rule also extends to individuals making “suspicious” transactions “near” that amount.  Let’s say you deposit $9,500 cash one day in the bank and the next day, deposit $5,200.  They’re still going to flag you and the IRS may begin to scrutinize your return to look for inconsistencies.  Is it fair?  Not really, but nobody ever said that 70,000 pages of tax law was right

The key thing to remember is this:  an audit isn’t saying you did something wrong, it’s saying that something in your return simply doesn’t match up.   The good news is this:  the odds of being audited are incredibly low if your income is less than $200,000/year.  Even if you’re a millionaire, the odds still aren’t that high, either.  

The truth is, in many cases, taxpayers with inconsistencies are usually simply sent a bill and expected to pay – and most times, that’s the exact advice I give – “it’s not worth fighting the IRS for this, just write the check and be happy.”  

On the other hand, if you find you’re going to go through a full audit, the smartest thing to do is to reach out to me and the team ASAP and begin to collect the information we need to fight – and win – against the IRS.  

Have a great day-

Ted Smith, CPA