How to Avoid – and Survive – an IRS Audit

Every year, the Internal Revenue Service examines (aka audits) a small percentage of U.S. tax returns to verify that the tax reported is correct. Both individual returns and corporate returns can be subject to an IRS audit.

What are my chances of being audited?

You are more likely to get struck by lightning. That may be an exaggeration, but the reality is that most taxpayers have only about a 1 percent chance of being audited by the IRS. If your annual income is more than $5 million, your chance of being audited goes up to 20 percent. Ironically, if you have no income, your chance of being audited is 3 percent.

The overall audit rate for business tax returns fell from 0.71 percent in 2012 to 0.61 percent in 2013, but audit rates are higher for small C-corps than for partnerships and S-corps. For small corporations (assets less than $10 million), the audit rate in 2013 was 0.95 percent.

Why would I get selected? 

Being selected for an audit does not necessarily mean there is anything wrong with your return. The primary way the IRS selects taxpayers to be audited is through computer scoring, known as the Discriminant Inventory Function system (DIF). Your return is entered into the computer and assigned a numerical score based on a variety of factors. Audit “risk” factors include low gross profit margin, high deductions such as auto, travel and entertainment expenses, and little or no profit from business operations.

Additional factors that can trigger an audit include when taxable income on your return doesn’t match amounts reported on forms to the IRS (W-2, 1099), mathematical errors, charitable contributions disproportionate to your income, claiming the home office deduction, and complex business or investment transactions.

Are there different types of IRS audits? 

There are three main types:

1. Correspondence audit: You mail in specific information requested by the IRS. This type of audit is the most common and least cumbersome.
2. Office audit: You take specific information requested by the IRS to their office.
3. Field audit: The IRS agent personally comes to your place of business. You are wise to have your attorney or accountant present for this meeting.

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Lisa K. Grossman, CPA, is an associate principal at Kaufman Rossin, and a leader in the firm’s QuickBooks consulting practice. Lisa is a Certified Public Accountant in the state of Florida and a QuickBooks ProAdvisor. Kaufman Rossin is one of the top CPA firms in the country. Lisa can be reached at lgrossman@kaufmanrossin.com.