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With one week to go before the regular tax filing deadline, let’s discuss how you can audit-proof your tax return.
Drum roll … you can’t.
I could stop right there, making this the shortest column I have ever written. But I suppose I should elaborate a bit on that rather harsh conclusion.
People who tell you that they can audit-proof your return begin with the claim that the IRS has a “secret” way of determining who will be selected for audit. Secret, that is, to all but the person making this claim.
Then the person with the inside scoop tells you that they will prepare your return in a way that minimizes what you owe to the IRS, but also presents the information in a way that will not lead to an audit.
Two of my daughters, who are fans of the Harry Potter series, might suggest that a return could be protected with a disillusionment charm, rendering it invisible to the Muggles working at the IRS.
Such a fantastic theory makes as much sense as the tales spun by the audit-proof crowd. Moreover, I might be able to greatly increase my income by offering such a charm with each return prepared for a Potter fanatic. I just need a good story as to why there will be no failure-to-file penalty when the IRS can’t see the return.
A clever crowd of tax wizards will back up their claims with audit insurance. For a premium, they promise to represent you in an audit and, for the right fee, even cover the added tax.
Ben Franklin famously said that only death and taxes are certain. But death can be a bit more burdensome, on both the deceased and his or her survivors, so it makes sense to purchase life insurance. Audit insurance is a consumer rip-off along the lines of refund anticipation loans.
While there is audit selection criteria that the IRS does not publish, IRS does publish audit rates by type of return, and it turns out the process is more logical than it is secret. This allows someone to price audit insurance so that, like all gambles, the “house” wins.
The more money you make, the higher is your risk of selection for audit. Secret exposed! Although only 1.1 percent of all individual returns are selected, 18.38 percent of those reporting adjusted gross income (AGI) above $10 million are audited.
In fact, the real trick may be how much “positive” income you have. This means income before considering your deductions. Positive income above $1 million brings an 8.4 percent audit rate because you resemble a plump retriever in the eyes of a tick.
Those claiming knowledge of IRS secrets will respond, “It’s not that easy.” Their proof? The audit rate for those with zero AGI is 3.19 percent, seemingly placing even your baby at risk. But these are folks who file returns, and report deductions that wipe out their income. Are these deductions valid? Inquiring minds want to know 3.19 percent of the time.
Returns claiming the earned income credit and the “first-time” homeowner’s credit also have a higher risk of audit, as do returns with self-employment income.
It turns out that people with virtually all of their income reported to the government on a W-2 or a Form 1099 have low audit exposure. These folks are more exposed than a TSA screening “customer” and are great candidates for a sale of audit insurance.
People with a lot of income that is not reported to the IRS have a higher propensity to forget all the pesky details when they have to file their return. I can sympathize with the claim that it’s hard to remember everything that happened last year.
Most IRS audits are not as threatening as a casual viewing of TV sitcoms might suggest. In fact, 78 percent of all audits are the “correspondence” type, which means you have no face-to-face contact with elements of the dark side.
Now admittedly, opening your mailbox and finding a letter from the IRS may rank even below a summons for jury duty. But at least it’s above watching an episode of “Jersey Shore.” And you can’t even buy insurance against that.
James R. Hamill is the director of tax practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.
