Federal tax audits are up of late. The IRS is taking a more aggressive approach in an effort to help close the tax gap, estimated at $345 million in unpaid and underpaid federal income taxes. The IRS claims to be "showing consistent improvements in areas critical to maintaining a fair, efficient tax system while bringing billions of additional dollars into the Treasury."

The IRS can audit your tax return for a period of three years, assuming you filed the return in the first place and there was no significant fraud involved―but you're most likely to be audited within the first 18 months.

Although the IRS actually audits very few tax returns as a percentage of the total returns filed each year, it is the very real threat of an audit that helps ensure voluntary compliance with the law. After years of decline, the threat of an audit has been growing.

Audit Statistics for 2007
The IRS' annual data book for fiscal 2007 reports that the IRS collected $2.4 trillion in taxes and processed 235 million returns during the period. The cost to collect each $100 in revenue was the lowest ever―approximately 40 cents.

The data book also provides the following audit statistics:

  Individuals Of the 135 million individual income tax returns filed for 2006, 1,384,563 of them were audited during fiscal year 2007, or approximately 1%. This is up from the number audited the previous year. 

  S Corporations The audit rate for S corporations was 0.5%, which is also up from 0.38% for 2006.

  C Corporations For corporations with less than $10 million in assets, the audit rate was 0.9%, or 0.1% higher than the prior year. While the rate was much higher for larger corporations―i.e., those with $10 million or more of assets―it is actually declining. It was 16.8% for 2007, as compared to 18.6% for 2006.

  Partnerships For partnerships, the audit rate was up slightly to 0.4% from 0.36% the previous year.

Over the last few years, the increase in audits is even more dramatic.

  In 2005, the total number of individual returns that were audited increased by over 20%―from 1,008,000 in 2004 to 1,216,000.

  Audits of wealthy individuals with incomes over $100,000 grew to more than 221,000 in 2005―or an audit coverage rate of 1.58%. This is more than double the 92,000 audits conducted in 2001.

  After a number of years of decline, audits of smaller corporations increased to 17,867 in 2005―up from 7,294 a year earlier.

Potential Audit Triggers
So, how were these audit targets selected?

As you might guess, returns with math errors or missing information are subject to additional scrutiny. Also, the higher your income, the greater the likelihood you will be audited. High-income non-filers are especially hot targets for the IRS. If you've been audited before and the examiner found that you owed additional taxes as a result, you're also at higher risk. The IRS also selects a small number of returns for audit on a random basis.

However, most returns selected for audit are initially flagged by a mysterious computer program at the IRS referred to as the discriminant function system, or DIF. It is believed to flag returns with items that differ significantly from national norms, require proof or explanation, or are on an IRS list of hot tax issues.

Your chances of being audited by the IRS tend to be greater if your federal tax return includes any of the following items: 



The fact that these items may increase the likelihood of an audit doesn't mean that you should exclude them from your return. Just be sure to retain all supporting documents. In fact, it's always smart to keep detailed and well-organized records in the event that you are audited.

ituation?

Scott Usher is a senior manager in the Bader Martin tax practice and a member of the firm's Real Estate Services group.  Scott provides a blend of tax and business consulting services for privately held businesses and their owners. He has extensive experience with federal, state, multi-state, and local tax planning and compliance for C corporations, S corporations, partnerships, and individuals. He is also well versed in international tax matters.

Save article

Email Bader Martin

Email to a Friend