Small Business Finance News

Rate Of IRS Audits Unchanged For Incomes Less Than $200K

Written by Tim Morral
Published: 10/15/2012

The rate of IRS audits is up 50% for higher incomes, but remain unchanged for incomes less than $200K per year.

Although the risk of random IRS audits is still low, recently released IRS data shows that the frequency of audits have increased by 50 percent over the past six years for taxpayers reporting more than $200,000 in income, while audit rates for taxpayers earning more than $1 million have doubled.

Trends and Statistics for Rate of IRS Audits

During the same time period, the audit rate for taxpayers reporting less than $200,000 per year has remained steady at 1%.

The Watson CPA Group points out that audited tax returns are selected based on scoring by the Discriminant Inventory Function System (DIF) -- a process that rates all tax returns according to their potential for adjustments or errors using historical data and IRS experience. Essentially, the system is weighted toward audits that have the highest probability of resulting in a revenue gain for the IRS.

Although the precise formula for determining which tax returns are marked for audits is a closely guarded IRS secret, the Watson CPA Group has identified several factors that can help business owners who want to learn how to avoid an IRS audit.

  • Income Swings. Although wage variations won't usually trigger an audit, swings in small business income, capital gains or other areas can catch the IRS' attention.
  • Small Business (Self-Employment) Losses. Business and self-employment losses have historically been used (and abused) as a tax shelter. The IRS expects any taxpayer who claims a business or self-employment loss to be able to prove that the business exists to earn a profit. Otherwise, it will be deemed a hobby -- and the loss will be non-deductible.
  • Large Deductions. Mortgage interest, charitable contributions and other large deductions can be suspect if they fall outside of the norm. To protect yourself, maintain accurate receipts and other forms of documentation.
  • Home Office Deductions. With telecommuting now a popular work option, audits triggered by home office deductions have become less commonplace. However, scores of taxpayers and business owners continue to take non-allowable home office deductions that could be vulnerable in the event of an IRS audit.
  • Meals & Entertainment Expenses. Exorbitant amounts of meal, entertainment and travel expenses are low-hanging fruit for IRS agents. Deducting travel expenses can trigger audits because the IRS has been very successful at increasing tax liabilities by placing these types of expenses under a microscope.


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