The Odds of a Tax Audit (And How You Can Reduce Them)

Picking the wrong preparer can increase your audit risk.
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Getting audited by the Internal Revenue Service can be a nightmare. Fortunately, it's not that common for most people. During 2011, the IRS audited a little more than 1.56 million of the more than 140.8 million individual returns filed, or just about 1.1 percent.

But despite the relatively low risk, it's always worth a little worry: The IRS selects some returns randomly for audit. In most cases, say preparers, the IRS has three years from the time you file to audit a return. If it determines you under-reported income by 25 percent, it can look at your returns for six years back. If the agency suspects fraud, it can audit any time.

The IRS doesn't reveal much about what factors trigger an audit, but some of its data speak for themselves. Tax preparers also say in their experience, some taxpayers and tax situations carry higher audit risks than others.

A home office deduction is "hard to calculate, and most people calculate it incorrectly."

Michael Rozbruch, founder of Tax Resolution Services Co.

Red Flag: High Incomes

The more you make, the bigger your audit risk becomes. According to the IRS, 2.66 percent of returns from taxpayers making $200,000 to $500,000 were audited, and 11.8 percent of those making $1 million to $5 million. Make more than $10 million? Odds of an audit are a little better than one in three.

Obviously, there's not much you can do about your income, but a greater chance of being audited makes it even more important for those with very high incomes to dot every "I" and cross every "T" on your return, said Steve Katz, an attorney with Sideman & Bancroft in San Francisco.

Red Flag: Misreporting Income

If the numbers you file don't match what the IRS receives from your employer, broker and financial institutions, that's a big red flag, said Tim Gagnon, assistant academic specialist of accounting at Northeastern University's D'Amore-McKim School of Business. Assuming you're not trying to hide income, the slipup can happen in several ways. Filing before your brokerage sends out revised 1099s leads to a mismatch. "They'll say you failed to report it," he says.

Banks aren't required to send you a 1099 unless you made more than $10 in interest, but some will report even lesser amounts to the IRS -- resulting in another mismatch. Make sure you report all income, and revise your return as needed if new information comes to light after you file, Gagnon said.

Red Flag: A Sketchy Preparer

The IRS has been cracking down on preparers that it thinks have been improperly handling returns, Katz said. That can mean that you, as a client, get audited to see if the funny business extended to your return. To limit your risk, choose a reputable preparer who has good reviews, and isn't likely to suggest taking deductions for which you aren't qualified, he said.

Red Flag: Claiming a Home Office

Having business income raises your risk. In 2011, the IRS audited 1.3 percent of individual taxpayer returns claiming less than $25,000 in business income, and 2.9 percent of those claiming $25,000 to $100,000. In particular, taking home-office deductions can draw attention, said Michael Rozbruch, founder and chief executive of Tax Resolution Services Co. "It's hard to calculate, and most people calculate it incorrectly," he said.

To qualify, a home office must be used solely for business -- it can't be, say, a part-time guest room. Only then are a portion of expenses such as rent, utilities and insurance become deductible. Be vigilant about use of the space to back up your claim in the event of an audit, he said.

Red Flag: Excessive Deductions

The IRS regularly puts out "Statistics of Income" bulletins detailing average deductions for taxpayers in various income brackets. In 2009, for example, the average taxpayer with an adjusted gross income between $50,000 and $100,000 claimed $7,269 in medical expenses and $2,775 in charitable donations. The government hasn't said specifically, but it's a safe bet that "if you're somewhere within that range, you're less likely to be audited," said Gagnon.

Outsized deductions can indicate you're hiding something. That's not to say you can't legitimately have high medical bills or more substantial charitable contributions than in previous years. But be prepared to back those up with documentation, he said.

Audit Myths

The fear factor of audits can blur what's real about them -- and what isn't. Not everything you hear about audits is true.

One common myth: Only rich people get audited. During 2011, the Internal Revenue Service audited 3.42 percent of returns where the taxpayer claimed zero in adjusted gross income, and 1.22 percent of those making $1 to $25,000. Claiming the Earned Income Credit can also heighten audit risk, said Tim Gagnon, assistant academic specialist of accounting at Northeastern University's D'Amore-McKim School of Business.

Taxpayers aren't as likely, as they fear, to face an in-person interrogation, either. In 2011, 78.3 percent of audits were so-called correspondence audits, conducted via mail. Resolving the audit can be as simple as providing documentation to back up a claim, said Michael Rozbruch, founder and chief executive of Tax Resolution Services Co.

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