IRS Turns to Computers to Choose Who Gets Audited and Who Doesn't

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Taxpayers audited by the IRS aren't selected randomly by humans any longer. They're chosen methodically by computers looking, line by line, for irregularities in tax returns. An Internal Revenue Service (IRS) audit can make even an honest and thorough taxpayer worried. In fact though, an IRS audit is simply a review of your tax return to determine how accurate it is.

Taxpayers Likely to be Audited

People who receive cash for their work instead of or supplementing a paycheck are more likely to be audited than others because people in these lines of work such as servers and hairstylists often do not declare all of their income and the IRS realizes this. The best way for these workers to do well in an audit is to declare all of their income and this includes tips.
People who run their own businesses are also likely to be targeted for an IRS audit. If you notice that accountants, lawyers and doctors tend to be audited, many of them run their own businesses and are responsible for their own bookkeeping.
Taxpayers who make large and unusual deductions are readily spotted by IRS computers so people who make these types of deductions should be sure they are justified.
Deductions such as medical and casualty loss that must exceed a certain amount of your income before they can be claimed, large charity contribution deductions and home office deductions are the deductions most likely to be questioned.
Other factors that increase the chance of an IRS audit include drastic changes in income from year-to-year, a lot of round numbers on your return such as 5,000 as these are rare in real life, incomplete or illegible returns, a low income compared to place of residence or financial obligations and differences between federal and state returns because employees do compare data on returns.

To help combat the problem of taxpayers who don't pay all of their taxes, officials at the Internal Revenue Service have announced plans to start a new National Research Program (NRP) study for individual taxpayers that will provide updated and more accurate audit selection tools.

The IRS will be choosing 13,000 taxpayers for audits at random for the study. The IRS plans to select taxpayers from various income categories and use the data collected to update the criteria it uses to determine what returns to audit with the goal of doing a better a job of catching people who don't pay their taxes in full or at all. A sample of 13,000 taxpayers is small compared to the around 136 million people who pay taxes yet the 13,000 taxpayer audit will probably include more people than a regular audit.

This latest NRP study, which will begin in October 2007 and examine approximately 13,000 random tax year 2006 individual returns, will be the first of an ongoing series of annual individual studies using a multi-year rolling methodology. Similar sample sizes will be used in subsequent tax years.

An advantage of using this method compared to previous studies which selected tax returns from over 45,000 taxpayers during a single year is that by combining results over rolling three-year periods, the IRS will be able to make updates and develop more efficient plans on an annual basis, after the initial three studies.

The main reason for these random audits is to reduce the nation's tax gap, which results from un-filed returns, underreporting income and underpaying taxes. The tax gap is the difference between what the IRS receives in tax payments and what they should have received from taxpayers. To an individual taxpayer, the tax gap might not seem like a lot, but it adds up. IRS officials estimate that the net tax gap for tax year 2001 was $290 billion.

The initial group of 13,000 taxpayers whose returns are chosen for audit under the new NRP study will begin receiving official letters in October informing them that they are part of the IRS research study. The majority of the individuals selected will have certain lines of their tax returns confirmed during in-person audits with an IRS examiner. When deciding whether you need a tax professional to help you face an in-person IRS audit, consider the tax amount being questioned compared to the cost of professional assistance.

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What You Need To Know About An IRS Audit

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Whether it is for a face-to-face or a correspondence audit, you have problems if you receive a notice for an audit from the IRS.

Correspondence Audit

The mail is how a correspondence audit is done. The IRS computers review every tax return and figure out if there are necessary corrections. If so, a notice is mailed to the taxpayer. This IRS notice should not be dismissed. Take action promptly, especially if it says you need to pay additional taxes. Interest and penalties may be added to the bill with delays. If you don't agree with the notice, send your reply and attach documents to prove your case. Keep copies of the correspondence for your records.

Face-to-face Audit

If you get a notice requesting you to call for an appointment or specifying a time and date to meet with a revenue agent or tax auditor, you have a face-to-face audit about to happen.

What do I do next?

The IRS will take action and mail you a bill if you don't respond within thirty days.
Follow the directions on the notice to know the specifics of the audit and what information you must bring with you.
Organize your documents. You have to prove that your tax return is right. The auditor's job will be made easy if you go to the audit organized and prepared. Consider this a plus.
You need supporting documents to present your case, so request duplicates of missing documents right away.
Do not bring information not requested to the audit. Inform the auditor that the information isn't available if brought up.
Be calm and courteous throughout the audit.
Only copies should be provided to the auditor, not original documents.
"Yes" or "no" are neutral responses to queries. Sensitive information can be taken from small talk. If you talk about making a big purchase or having just returned from a vacation, the auditor might find cause to believe that you have not revealed all your income on your tax return. This might be a reason to expand the audit.
Know that you have a right to an appeal if you do not agree with the audit's outcome.

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Information About Filing an Amended Tax Return

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Naturally, you don't want the IRS to come across some discrepancies in your tax returns because this can lead to a serious problem in the future. Hence, it is always in your best interest to file an amended tax return if you discovered that you have some errors on last year's tax return or the one you just sent through the mail. If the errors are merely a result of miscalculations, there is no need to file an amendment as the IRS will take care of adjusting them and informing you about this. However, there are errors that need to be corrected by you as doing otherwise could lead to problems.

Usual errors are discrepancies in deductions or credits, total income, dependents and filing status. Be primed, however, that correcting some information in your return may lead you to either receive a refund or incur penalties.

Form 1040x, Amended U.S. Individual Income Tax Return, is utilized to file for an amended tax return. This will correct the tax return filed under Forms 1040EZ, 1040A, or 1040. Whether you originally filed through e-filing formats or simply sent it through the mail, you must submit amended tax return through the mail. The IRS' e-file systems are not yet capable of receiving electronic 1040x forms. In the 1040x, you are simply asked to identify the data that need to be amended as well as the reasons for the requested adjustments.

One of the most popular reasons that people file amended tax returns is when they need to correct their filing status. Form 1040x allows you to claim the deductions that are otherwise taken from you if you filed under the wrong status. Changes from single to head of household status are among the most common requests for this type of information. There is a considerable difference in the level of deduction available to those who qualify as head of household.

You have the ability to file an amended return anytime within the three years following that specific tax return's filing date. However, only those who have settled all their tax bills on the tax return in question will qualify for this three year grace period. If the tax bill was not fully paid, then the grace period is decreased to only two years.

If you have recently filed and you have discovered an error, you may want to wait until you get your refund and all of the paperwork for that tax return has been processed before filing an amended tax return. This will avoid any confusion regarding your tax record or any duplication of paperwork, thereby eliminating the probability of an IRS problem.

Conversely, there are situations when filing for an amended tax return means paying or owing the IRS more money. While you may not want to file one, in the end it is truly in your best interest to do so to avoid a more serious IRS problem. There is a very good chance that the IRS will find out about the mistake on your initial tax return. In this situation, they are more likely to give you higher fees and penalties as compared to when the mistake was brought to their attention through your amended tax return.

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How to Deal With an IRS Audit

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When it comes to their rights during an IRS audit, most people simply have no idea. Luckily, even if they don't understand their rights, their rights are still protected and should not be violated by the IRS during the course of the audit process. In an audit process, the most essential right is the right to an explanation of what is going on and what's going to happen in the whole audit process. You also have the right to be represented by a tax attorney, CPA, or enrolled agent, just like any legal proceedings. It's your right to claim additional deductions that were unclaimed on your original tax return. You also have the right to file a request to the national office of the IRS on a particular problem that may arise during your audit with your specific IRS agent. Being aware of your rights ensures that you're treated justly by the IRS auditor and can make the process much seamless.

When you get your notification that you're being audited, there are some things you can do that can offer you a slight benefit over persons who don't know how to deal with an audit. You can request postponement of your audit, for instance. This way, you'll be able to refresh your memory about why your tax records were accomplished in the way that they were, as well as have enough time to gather financial documentation. Another advise that must be followed by everyone who is going through an audit is to read IRS Publication 1. This is the Taxpayer's Bill of Rights. This booklet contains the basic rights provided to any US taxpayer.

It is also advised to meet with your counsel before the audit, whether you're being represented by a tax lawyer or a CPA. This way, you can brainstorm for strategies on how to deal with the points brought up by the IRS auditor.

An essential tip is to only bring those documents which the audit notice has asked for to prevent a bigger IRS issue. You don't want to bring or provide more details to the auditor than what the audit notice has outlined. This will encourage the auditor to probe into areas that they initially were not going to delve into. Simply put, you don't want to give them any more ammunition.

Being ready is the best way to end an audit quickly. The auditor will see that you'll be able to back up any issues of your tax return with documentation if you're able to support all your claims.

Regardless of how heated the situation becomes, it's always best to be professional. Of course, the IRS auditor has to treat you the same way. Lying must be avoided at all costs. Telling the truth can prevent many IRS problems.

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How to Deal With an IRS Audit

Image : http://www.flickr.com

When it comes to their rights during an IRS audit, most people simply have no idea. Luckily, even if they don't understand their rights, their rights are still protected and should not be violated by the IRS during the course of the audit process. In an audit process, the most essential right is the right to an explanation of what is going on and what's going to happen in the whole audit process. You also have the right to be represented by a tax attorney, CPA, or enrolled agent, just like any legal proceedings. It's your right to claim additional deductions that were unclaimed on your original tax return. You also have the right to file a request to the national office of the IRS on a particular problem that may arise during your audit with your specific IRS agent. Being aware of your rights ensures that you're treated justly by the IRS auditor and can make the process much seamless.

When you get your notification that you're being audited, there are some things you can do that can offer you a slight benefit over persons who don't know how to deal with an audit. You can request postponement of your audit, for instance. This way, you'll be able to refresh your memory about why your tax records were accomplished in the way that they were, as well as have enough time to gather financial documentation. Another advise that must be followed by everyone who is going through an audit is to read IRS Publication 1. This is the Taxpayer's Bill of Rights. This booklet contains the basic rights provided to any US taxpayer.

It is also advised to meet with your counsel before the audit, whether you're being represented by a tax lawyer or a CPA. This way, you can brainstorm for strategies on how to deal with the points brought up by the IRS auditor.

An essential tip is to only bring those documents which the audit notice has asked for to prevent a bigger IRS issue. You don't want to bring or provide more details to the auditor than what the audit notice has outlined. This will encourage the auditor to probe into areas that they initially were not going to delve into. Simply put, you don't want to give them any more ammunition.

Being ready is the best way to end an audit quickly. The auditor will see that you'll be able to back up any issues of your tax return with documentation if you're able to support all your claims.

Regardless of how heated the situation becomes, it's always best to be professional. Of course, the IRS auditor has to treat you the same way. Lying must be avoided at all costs. Telling the truth can prevent many IRS problems.

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Some Common IRS Flags For Audits

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Any taxpayer will be happy to know what will catch the attention of the IRS enough for them to subject you to an audit. Over the years, tax returns are mostly processed by computerized systems. The general idea is that the programs simply detect anything that is considered 'out of the ordinary', and when each tax return is compared to the statistical average, or what is considered normal when the group is examined as a whole, it treats that difference as a flag. This flag increases the chances that such particular tax record will be audited. After the computer flags the tax record, it will be manually rechecked by an IRS employee, depending on the extent of the discrepancy that the IRS computer found. In some instances, the IRS computer will simply print out a notice that will delivered directly to the taxpayer.

Audit flags will certainly increase your likelihood of being audited. There are several easily avoidable audit flags that the IRS seems to deal with regularly. One of the easiest to avoid is turning in sloppy tax returns that are also incomplete. You may want to ensure that your tax returns are nearly perfect with both the math calculations and the information provided. If there are miscalculations found in your tax return, it will then be sent to an actual IRS agent who would have to manually review it. Electronically filed returns are less likely to have this kind of mistake as the system has a built-in math checker.

Not reporting all of your earnings to the IRS will do you no good. Basically, anyone who gives you a W-2 or 1099 also sends a copy to the IRS. This explains why the IRS has an accurate record of everything you earn and if you try to outsmart them by not giving them complete reports, you are certainly up for an IRS audit. Miscellaneous income, dividends, and interests must always be reported as part of your income so you won't have problems with the IRS.

Also prone to an IRS audit are taxpayers who report that they are either making a great deal less or a great deal more than the industry norm. Statistics suggest that almost 5% of all taxpayers get an audit every year for this reason. In addition, those who are earning more than $100,000 yearly have 5 times more chances of getting an audit.

If your tax record shows extreme fluctuations in your income level, that will again be considered as an audit flag. The IRS takes notice of this because they believe that most people do not have such large differences in income levels. Usually they will think that you have underreported your income at one point or another.

As surprising as it may sound, even having too many round numbers on your tax return can raise an audit flag. For instance, most transactions aren't exactly $1,000 or $500. Having this kind of numbers would make the IRS think that you have been rounding up too many transaction records and you are certainly up for something. This will, at least, prompt the system to force an actual IRS agent to recheck your tax return.

There are still a lot of audit flags out there and the ones mentioned above are just the most common ones. Knowing what to be careful about will certainly help you in avoiding an IRS problem.

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Some Common IRS Flags For Audits

Image : http://www.flickr.com

Any taxpayer will be happy to know what will catch the attention of the IRS enough for them to subject you to an audit. Over the years, tax returns are mostly processed by computerized systems. The general idea is that the programs simply detect anything that is considered 'out of the ordinary', and when each tax return is compared to the statistical average, or what is considered normal when the group is examined as a whole, it treats that difference as a flag. This flag increases the chances that such particular tax record will be audited. After the computer flags the tax record, it will be manually rechecked by an IRS employee, depending on the extent of the discrepancy that the IRS computer found. In some instances, the IRS computer will simply print out a notice that will delivered directly to the taxpayer.

Audit flags will certainly increase your likelihood of being audited. There are several easily avoidable audit flags that the IRS seems to deal with regularly. One of the easiest to avoid is turning in sloppy tax returns that are also incomplete. You may want to ensure that your tax returns are nearly perfect with both the math calculations and the information provided. If there are miscalculations found in your tax return, it will then be sent to an actual IRS agent who would have to manually review it. Electronically filed returns are less likely to have this kind of mistake as the system has a built-in math checker.

Not reporting all of your earnings to the IRS will do you no good. Basically, anyone who gives you a W-2 or 1099 also sends a copy to the IRS. This explains why the IRS has an accurate record of everything you earn and if you try to outsmart them by not giving them complete reports, you are certainly up for an IRS audit. Miscellaneous income, dividends, and interests must always be reported as part of your income so you won't have problems with the IRS.

Also prone to an IRS audit are taxpayers who report that they are either making a great deal less or a great deal more than the industry norm. Statistics suggest that almost 5% of all taxpayers get an audit every year for this reason. In addition, those who are earning more than $100,000 yearly have 5 times more chances of getting an audit.

If your tax record shows extreme fluctuations in your income level, that will again be considered as an audit flag. The IRS takes notice of this because they believe that most people do not have such large differences in income levels. Usually they will think that you have underreported your income at one point or another.

As surprising as it may sound, even having too many round numbers on your tax return can raise an audit flag. For instance, most transactions aren't exactly $1,000 or $500. Having this kind of numbers would make the IRS think that you have been rounding up too many transaction records and you are certainly up for something. This will, at least, prompt the system to force an actual IRS agent to recheck your tax return.

There are still a lot of audit flags out there and the ones mentioned above are just the most common ones. Knowing what to be careful about will certainly help you in avoiding an IRS problem.

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