IRS Audit Rates Decline in 2014

Audits rates declined in 2014 and are likely to go down more in 2015.

IRS audit rates are falling rapidly. In 2014, the IRS audited only 0.86% of all taxpayers, the lowest rate in over a decade. The IRS performed over 160,000 fewer audits than in 2013, when the overall examination rate was 0.96.%. 2014 marks the third year in a row that the examination rate has declined. The reason: Big cuts in the IRS budget combined with an increase in the number of returns being filed. Because of the cuts, the IRS’s audit staff has been reduced by more than 600 revenue agents.

However, the 0.86% number is a bit misleading. Your odds of getting audited vary according to your income. Those with higher incomes are audited more often. Taxpayers with incomes over $200,000 had a 2.71% audit rate; while those with incomes over $1 million were audited 7.5% of the time. In contrast, taxpayers making less than $200,000 had only a 0.78% audit rate, and the vast majority of these exams were the less thorough correspondence audits.

It’s likely that the audit rate will decline even more in 2015 because the IRS budget has been cut by an additional 5%. The cuts are part of continuing payback by the Republican Congress for the alleged targeting of conservative nonprofits by the IRS.

Does this mean you no longer need to fear the IRS? Not really.

Although the overall audit rate is low, the IRS audited over 1.2 million taxpayers in 2014. This is a drop of 162,000 from 2013, but there are still lots of people getting audited.

Moreover, the audit rate only includes in-person examinations conducted by IRS revenue agents and correspondence audits by IRS Service Centers. But these aren’t the only tools the IRS uses to go after tax evaders. Every year IRS computers match the data on taxpayers’ returns with third-party reporting information received by the IRS on Forms W-2 and 1099s. About four million returns are flagged each year by IRS computers in this matching process, with the taxpayers sent notices demanding extra payment or an explanation for the mismatch. The IRS doesn’t count these notices as audits. If they were counted, the examination rate would be close to 4%.

Moreover, the IRS uses sophisticated software to decide which returns to audit. One way the IRS decides whom to audit is by plugging the information from your tax return into a complex formula to calculate a “discriminate function” score (DIF). Returns with high DIFs have a far higher chance of being flagged for an audit, regardless of whether or not you have done anything obviously wrong. Anywhere from 25% to 60% of audited returns are selected this way. Exactly how the DIF is calculated is a closely guarded secret, but your odds of getting audited go way up if, for example:

  • your deductions are unusually large for your income
  • your deductions are peculiar--—for example, a plumber deducts the cost of a European vacation as a business expense
  • you have a money-losing business
  • you have a lot of hot-button deductions such as substantial charitable deductions; or big deductions for auto, travel, and entertainment expenses, or
  • you have a business that deals with a lot of cash.

The only sure way to avoid getting in trouble with the IRS is to pay what you owe.

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