When does the IRS Audit?

When does the IRS Audit?  That’s a question a lot of people want to know.  The short answer is generally within 3 years… but there are some guidelines they follow.  If there are large mistakes (the IRS calls it substantial understatement), the IRS can go back six years instead of three.  If they find fraud… bummer, they can go back as far as they want.

Most of the time, within a minute or two, we can see on a filed tax return WHY the IRS chose the return for audit.  In most cases there is a big flag that begs for additional information and the IRS keys in on it so they can ask about it.  Many times it’s a big loss or unusual tax item.  We have seen many cases too, where someone has put an income item on the wrong line, which almost always puts the IRS on alert.  In our experience, we see that the IRS usually picks these items up in about  12 to 18 months.

Another way the IRS picks up a tax return for audit is when the tax return excludes an income item that the IRS is aware of.  How does this happen?  Good question.  The IRS receives all kinds of information from individuals and companies that you do business with.  The common ones are W-2s from your employer and 1099s if you are an independent contractor.  Additionally, there are all kinds of 1099s from banks (interest and dividends) and brokerages (dividends and stock sales).  These are just a few of the many items that can be reported by third parties.  The IRS matches these items against your income tax return reporting and if they find that something is missing they can either open up an audit, or simply make changes to your return and send you a bill. If you don’t protest the bill, the additional amount due becomes a legal debt to the IRS. Our experience is that the IRS is able to match this info and contact you within 6 months to a year.

As a note of interest, particularly if you have a tax problem, you can obtain this information that has been reported to the IRS .  You can call the IRS (800)829-1040 and ask for your income information (be sure to specify the year) and they can send this information to you.  Beware however, if you are already in the collections bull’s eye the IRS will most likely start asking questions about where you work and where you bank.  They are not making pleasant conversation… they want to know where they can take your money.  They CAN garnish your wages and take the money out of your bank accounts without permission from you.  If you are concerned about these types of questions, you can still get the information but it’s a little more involved.  You can request the information as far back as the last 6 years through a process called a FOIA request (Freedom of Information Act Request).  Through this formal process, you can request the information and by LAW the IRS has not only to honor your request, but it CANNOT contact the collections department to let them know.  It’s a very good way to get the information you need without waking up that sleeping big dog!!!  If you are already getting levied or garnished, it won’t hurt to call them and save the additional time and money requesting the information as they already know where the money is.

Another type of audit is the random audit.  The amount of completely random audits can vary, but it can be about 50,000 taxpayers that are just blindly and randomly picked.  This audit is a very big bummer, as they are going to most likely go over every number in your return and demand proof.  The IRS uses this type of information to see where people are making mistakes (or cheating) so that they can create processes that zero in on people with these types of issues.  The goal is to find and audit more people they feel are likely to have these kinds of mistakes.  In other words, they want to streamline the process of determining where they can find more money faster.

With the last paragraph in mind, the IRS has created a system of determining what kinds of returns are likely to have errors that will produce audit revenue most effectively.  They protect the secrecy of the criteria for choosing their audit picks very carefully, and I would deem it impossible to get ahold of that information.  There are some items that are generally known to increase your chance of audit.  For example, Schedule C (the form for self-employed individuals) is the most audited form in the history of the IRS.  If you have $100,000 in GROSS income on a schedule C, you have a much higher probability than your neighbor who has a similar income as you but works for someone else.  There are many reasons to incorporate a small business, but audit risk is one very good one.  If you incorporate and have the same income, you are tossed into the audit pool with the big corporations.  Compared to the Fortune 500 corporations your income suddenly seems like nothing at all!  Now, let the taxpayer beware… before you incorporate you should contact a professional to make sure it’s a good idea for your specific circumstances.  There are many good reasons NOT to incorporate, and I’m only suggesting ONE idea in this short article.  This is not a sale’s pitch either…  we do NOT assist with incorporating a business as that is not what we do.  We fix tax problems and we prepare taxes.  We hope to keep people on track and doing it right, so incorporations and such is not what we do.

As mentioned in the first paragraph, this audit must be accomplished within 3 years of filing a tax return.  It can be increased to 6 years if there are large mistakes, and it can be increased indefinitely if they find fraudulent items.

Additionally, there is no limit to the amount of time they have if you haven’t filed a tax return.  The 3 year statute for auditing a tax return starts on the day the return has been properly filed with the IRS. If you haven’t filed, that 3 year period doesn’t ever start and thus, the IRS has forever.

If you haven’t filed yet, you may want to consider reading the section on procrastinators.  There is some great information there as to how to get back into the system and how long you have to file a return if you may have a refund!