Reality Check

Reality Check

Vets the truthfulness of claims and measures the efficacy of public policy

Reality Check: Tax Deadline Approaches - Do You Feel Lucky?

The odds of an IRS audit are miniscule for most Americans, with the exceptions sitting on both ends of the income spectrum.

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    NEWSLETTERS

    In this edition of Reality Check, Sam Brock examines the claims that the "super rich" filers get targeted more and that the IRS conducts "random" audits. (Published Monday, Apr 14, 2014)

    As we approach the April 15th tax deadline, many of us [procrastinators] will feel ambivalence upon pressing the ‘submit’ button on our e-file forms or dropping the 1040 papers into the mailbox.

    Relief, certainly, of a process that is now complete. But also the slightest hint of, shall we say, nervousness?

    Every year a certain percentage of tax filers are audited by the IRS, and we just hope not to be included in that group.

    So what are your chances?

    If the data for the FY 2013 numbers is any indication — an IRS overview of who got snagged for the 2012 calendar year filings- the odds you’ll be selected are minute, generally speaking.

    According to an IRS spokesperson, somewhere between 146 and 148 million individuals filed income tax returns for the 2012 year.

    Of that group, less than 1 percent were red-flagged and given an “examination coverage,” in IRS speak.

    To be more precise, 0.96 percent of all filers got nabbed.

    For a full breakdown, go to this section of the IRS’s annual ‘Data Book’ and select 2013.

    But the overall audit number here does not tell the whole story.

    As you might expect, very wealthy taxpayers are given an extra level of scrutiny that is not on par with their less financially-endowed counterparts.

    If you filed returns last year with an Adjusted Gross Income (AGI) of $5 million or higher, you had a 16 percent chance of being audited. Bump up the AGI to $10 million plus, and there is about a one-in-four chance that the IRS came knocking (or more likely emailing) looking for more information.

    “It’s more likely that if you’re in that very, very high level income range that you’re going to be audited just because the IRS wants to make sure that you’re playing by the rules and you’re doing what you’re supposed to be doing,” said Caroline Chen, an IRS veteran of 13 years who now teaches at Santa Clara Law School and serves as director of the Low Income Taxpayer Clinic.

    Chen says there are many transactions that can “look” legitimate but are really used as cover to obscure generous flows of income.

    But while this may sound like a bit of witch hunt, Chen added that the IRS is “always driving towards the right answer.”

    What may come as more of a surprise is that folks with little or no reported income are also audited at a higher rate than everybody else.

    Americans with a reported AGI between $1 and $25,000 had an audit rate of 1 percent, just a tick above average.

    But those with no reported income saw their returns pulled at a rate of more than 6 percent, raising the question of why.

    Chen says it’s a fairly simple answer: The returns of those individuals did not match the documents submitted by third-party members, i.e. employers, banks or state and local governments, to the federal government.

    “Tax returns are just a matching, right?” Chen said. “The IRS is this HUGE computer, and the IRS receives information from your employer, and from the bank if you have a mortgage- how much mortgage interest you paid- and from your bank if you have dividends or if you have interest, and then you report on your own tax return how much money you made as an employee.”

    When there’s a discrepancy of a certain size, that’s when trouble occurs.

    Chen says you might get your refund initially, but the IRS has three years to perform an audit and come back demanding the money be repaid, with both penalty and interest.

    Why are lower-income filers more likely to find themselves in this group?

    “Because maybe they’re preparing their own returns or their returns are being prepared by incompetent tax return preparers,” she explained. “So there are just errors, so when the errors pop up it’s really easy for the computer just to start an audit.”

    Chen noted that only tax attorneys, CPA’s and enrolled agents are regulated by the federal government. Everybody else is not, opening the door for predatory practices and errors typically involving lower earners.

    “You don’t want to spend an enormous amount of money, especially if you’re not making an enormous amount of money to have your returns prepared,” she said, leaving poorer folks to use questionable providers or no providers at all.

    “But, you know, the problem is a lot of people don’t realize there’s a way to have your returns prepared for free,” Chen said.

    The ‘Volunteer Income Tax Assistance Program’ is a service funded by the IRS that provides free filing for those who meet a certain income threshold.

    Those providing the service are both competent and typically trained by the IRS, Chen said. The qualifying income level tops out around $50,000 of AGI.

    She said the United Way of Silicon Valley oversees and operates about 70 such sites in Santa Clara County.