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How likely is an IRS audit for a client?

As IRS budgets and audit staff continue to diminish, audit numbers are at an all-time low. But when you file your clients’ returns, the most common question persists: “How likely am I to be audited?”

Clients whose returns stray far away from the norm or have “large, unusual or questionable items” can always be singled out for audit. But overall, as the statistics bear out, the IRS likes to audit clients with certain characteristics.

To start, individuals get more audits than business and specialty taxpayers. In 2017, the IRS reported a 1 in 184 (0.542%) chance of being audited for all taxpayers. For taxpayers filing individual returns, the likelihood of audit is 1 in 161 (0.623%). Corporations (1120, 1120-S) and partnerships are audited less than individuals — with an audit rate of 1 in 224 (0.445%). In 2017, the IRS audited only 1 in every 568 (0.176%) employment tax returns (Forms 940/941).

Individual return audit rates
Out of the 150 million taxpayers who filed in 2017, here are the IRS statistics on who experienced an audit:

Form 1040 taxpayer types, in descending likelihood of auditReturns audited
International taxpayers1 in 19
Taxpayers with gross income before deductions of over $1 million1 in 23
Sole proprietors with gross income before deductions between $100,000 and $200,0001 in 48
Sole proprietors with gross income before deductions between $200,000 and $1 million1 in 64
Taxpayers with self-employment income under $25,000 who claim the EITC1 in 72
OVERALL INDIVIDUAL AUDIT RATE1 in 161
Farmers1 in 228
Wage earners who make under $200,000 and don’t claim the EITC (65% of taxpayers fit this category)1 in 364

The IRS is focusing its audit resources on areas where it knows clients are traditionally noncompliant: small businesses, international clients, high-wealth clients, and possible Earned Income Tax Credit fraud schemes. Traditional wage earners who have traceable income reported on Forms W-2 face much less scrutiny.

Business and specialty tax return audit rates
Out of the millions of returns filed by businesses, employers, and specialty taxpayers (estate, gift, trust returns), here are the IRS statistics on who experienced an IRS audit:

Business/specialty taxpayer types, in descending likelihood of auditReturns audited
Large corporations (Form 1120, assets greater than $5 billion)1 in 3
Estate tax returns1 in 12
Large corporations (Form 1120, assets between $10 million and $5 billion)1 in 23
Excise tax returns1 in 72
Gift tax returns1 in 130
Small corporations (Forms 1120, not 1120-S)1 in 146
OVERALL CORP/PARTNERSHIP AUDIT RATE1 in 224
Partnership returns (Form 1065)1 in 260
Estate and trust income tax returns (Forms 1041)1 in 971
Employment tax returns (Forms 940 and 941)1 in 568
S corporation returns (Forms 1120-S)1 in 358

The IRS questions more returns through automated matching notices
Audits are not the only way the IRS can question the accuracy of a tax return. Over the past 20 years, the IRS has ramped up more automated return checks in the form of matching programs. For example, in the IRS CP2000 program — the automated underreporter program — the IRS matches income between tax returns and IRS information to look for discrepancies. If there’s a mismatch, the IRS automatically sends out a notice asking for explanation. This program has increased 143% since 2000 — and it outnumbered audits 3.1 to 1 in 2017.

Clearly, smaller IRS budgets and personnel over the past seven years have even lowered the number of CP2000 matching notices. But automated notices have become the norm. And although CP2000 notices are not technically IRS audits, they allow the IRS to increase its ability to challenge returns far beyond what it can do through people-intensive audits. Matching notices also feel a lot like an audit for clients. If you add the CP2000 matching program to the IRS “return challenge” rate for individuals, the chances of the IRS challenging an individual taxpayer’s return come out to 1 in 35 instead of 1 in 161.

The cost of an audit can be high
Audits are likely to be costly. IRS data shows that over 90% of individual audits result in a tax change. The average additional tax owed is $6,014 for a mail audit and $21,918 for a more intrusive IRS field audit.

CP2000s can also be costly. The IRS collected $6.7 billion in additional tax on the 3,295,000 matching notices it sent in 2017 — an average of $2,033 per notice issued.

IRS audits and CP2000 notices

On top of the additional tax for audits and underreporter notices, there are accuracy penalties, which can add 20% to the tax bill. Since 2005, the IRS has increased accuracy penalty assessments by 854% — with more than 557,000 taxpayers getting an additional 20% penalty on their audit or CP2000 notice.

Do a proactive income review
For some clients, like international clients and higher-wealth clients, avoiding an IRS audit can be more difficult because the IRS believes that their returns are more likely to have errors and omissions.

For most clients, avoiding IRS scrutiny means reporting all wage and income documents (Forms W-2, 1099, etc.) to the IRS. Tax pros can’t get IRS information statements from the IRS before the end of filing season, so they need to rely on their client’s ability to provide them all the information.

Tax pros can do their best tax season due diligence by looking at last year’s return and IRS wage and income transcripts for sources of income. They can also do a post-filing review by obtaining their client’s current-year wage and income transcripts that are available during the summer, before the IRS issues the first CP2000 notices later in November. This post-filing review is still proactive before the IRS issues any notices. If tax pros find unreported income, they can file an amended return to avoid any potential accuracy penalty that could be associated with a notice or audit.

Clients who don’t avoid an audit or CP2000 notice will look to you for help. This is when tax professionals show their ultimate value to clients — by helping clients navigate and get the best results.

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