How are tax returns chosen for an audit? Do you know what percentage of personal returns are audited?

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How are tax returns chosen for an audit? Do you know what percentage of personal returns are audited?

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Posted by Doria Lavagnino (MONEY FORUMS: 3, Answers: 0)
Asked on July 2, 2016 9:50 pm
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This sounds like reasonable advice both as to who is likely to get audited and the precautions you should bear in mind when filing a return. It has been 11 years since I retired my CPA license but the criteria listed was what I anticipated when practicing. Especially vulnerable was Schedules C, for a small business and Schedule E for rentals. There is also just a common sense look at the overall return to see if it makes sense, i.e. having gross income and large deductions (how did you pay for it?) I think the point of understaffing at the IRS is also an excellent observation and not likely to change given the present political climate. Ruth Lavagnino

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Posted by Ruth Lavagnino (MONEY FORUMS: 0, Answers: 2)
Answered: July 23, 2016 6:50 pm
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Hi Doria, great questions!

The general answer to your first question is everyone’s returns are first analyzed by a computer system to “red flag” the ones that are most likely to have been underpaid and then they may undergo multiple human reviews before you hear from the IRS. The system is looking for statistical inconsistencies compared with other peoples returns, among other things.

More specifically, some things that may increase your chances of being flagged for review are excessive deductions against small business income, large charitable deductions, rental real estate losses, and early distributions from retirement accounts. Generally if you have excessive/unusual income or excessive/unusual deductions, these are likely to increase your chances of an audit.

To your second question, according to Kiplinger, about 0.85% of all filers have been audited in 2014 and 2015 and that number is falling because the audit team is apparently understaffed.

A couple of other things to note. First, and this goes without saying, honesty is the best policy. Small mistakes will have relatively minor interest and penalties. Fraud is much more serious.

Secondly, keep your records. You should generally have documentation of all income and deductions. I scan all of the documents I use to complete my return and save them digitally, preferably in a secure cloud storage. If you just made a mistake on the return, the statute of limitation is 3 years, after which they normally can’t audit you. It’s twice that, or 6 years, if you conceal more than 25% of your income and there are some tricks the IRS can use to lengthen that. There is no statute of limitations for tax fraud, though. I recommend hanging on to your records for 6-7 years.

Finally, if your return is pretty complicated and you just don’t feel comfortable that you know what you’re doing, especially if you have a lot of income and deductions, using a tax professional to prepare the return for you is probably a good idea. I would avoid the discount, national chain, tax-prep companies. Some of these places require shockingly little training of their employees. Look for a local CPA (Certified Public Accountant) or EA (Enrolled Agent) who specialized is personal and small business tax prep. For a normal personal return of a small business owner who owns a home, you should be looking to pay about $400 or less in my opinion.

I hope this is helpful!

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Posted by Dave Bowman, CFP® (MONEY FORUMS: 0, Answers: 2)
Answered: July 19, 2016 11:52 am
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