What Are the Odds the IRS Will Audit Your Tax Return? And What Should You Do If It Does?

income taxMy Comments: There is a significant difference between avoiding taxes and evading taxes. Not less an authority figure than a former Supreme Court justice expressed that “…there is no obligation to pay more in taxes than absolutely necessary”. But evading taxes will perhaps land you in jail.

That being said, the IRS is NOT going to tell you about every loophole or allowable strategy in the play book to help you pay less tax. Their job is to make sure that everyone earning money files a tax return and if a tax is dues, was it paid on time.

It’s up to us to figure out what we can do to avoid paying extra money in taxes than is absolutely necessary. One can argue that pushing the envelope is OK until you are caught. I’m not going to go there, but what follows is one element in the games we play.

By Kevin McCormally, May 31, 2016

Tax audits are in the news more than usual this year, since Donald Trump says the fact that he’s being audited by the IRS prevents him from releasing his returns as part of his quest for the presidency.

But if being audited blocked the release of a tax return, we never would have seen Barack Obama’s or George W. Bush’s or Bill Clinton’s or any other recent president’s. Even Richard Nixon released his returns while they were being audited (the fact that that return led to the House Judiciary Committee approving an Article of Impeachment against Nixon is another story).

Why? Because when it comes to the odds of being audited, one thing is crystal clear: If you’re living in the White House, your odds are 100%. The returns of the president (and the veep) get the going over every year, as required by section of the Internal Revenue Manual.

As the head of the IRS, John Koskinen, told us earlier this year, “So, you know, anyone running for president or who’s going to be president can look forward to having their tax returns audited every year.”

Assuming you’re not aiming to run the free world, though, what are your odds of being audited . . . and what should you do if you are?

This is the quintessential good-news/bad-news story.

The good news: If you’re worried that the tax return you just sent to the IRS will be audited, breathe easy. Koskinen is telling anyone who will listen that budget cuts have severely limited the agency’s ability to review returns for accuracy. Audit rates for individual tax returns fell last year to the lowest level in a decade … and will fall even more this year.

The bad news: If you’re an honest taxpayer, you’ll be disappointed to learn that the IRS says that every $1 it spends on audits and other “enforcement” activities brings in $4 to the U.S. Treasury. Falling audit rates mean dishonest taxpayers will be allowed to keep billions of dollars they ought to be paying in taxes.

But just what are the chances you’ll be audited, that your Form 1040 or 1040-A or 1040-EZ will be plucked from the 140 million-plus returns for a going over?

Clearly, the odds are reassuring. The vast majority (more than 99%, in fact) of individual income tax returns skate safely past the IRS audit machine.

Better news: The 1-in-119 chance of being called on the carpet vastly overstates the severity of the situation. More than three-quarters of all audits are handled by mail, not by mano a mano combat with an IRS agent during an office examination or a field audit. And if your return doesn’t include income from a business, rental real estate or a farm, or employee business expense write-offs or earned income credit, the basic 1-in-119 chance of being challenged dwindles to about 1-in-330.

Another piece of rarely reported good news: Each year, tens of thousands of taxpayers walk out of an audit with a check from the government. In 2015, for example, almost 40,000 audits resulted in refunds totaling nearly $1.1 billion. And 9% of field audits and 12% of correspondent audits end with the conclusion that everything is hunky-dory: no change in what the taxpayer owes Uncle Sam.

The 1-in-119 chance of being audited is the overall average from last year. As noted above, there’s an even smaller chance this year. But in any year, your personal odds turn on the kind of return you file and the type of income you report.

Our calculator, based on official IRS data on returns audited in 2015, will give you a good idea of the odds that your personal Form 1040 (or 1040-A or 1040-EZ) will be selected for review—either by mail or in person. And, remember, even if it is, there’s a decent chance you’ll walk away unscathed or be one of the lucky ones whose audit results in a refund.

With few exceptions, of course, the IRS doesn’t randomly choose which returns to audit, although random reviews are used to help the IRS calibrate the computers that identify the juiciest targets.

Over the next few months, the IRS will be plugging data from more than 140 million 2015 tax returns into a computer that scrutinizes the numbers every which way and ponders how the picture you paint of your financial life jibes with what it knows about other taxpayers. The computer tries to spot returns that are most likely to produce extra tax if put through the audit wringer. The computer’s choices are reviewed by a human being who can overrule them if, for example, an attachment to your return satisfactorily explains the entry that set the computer all atwitter. Short of such a veto, your name will go on the list.

Even if your return survives the computer’s scrutiny, you’re not necessarily safe. You may have listed an investment in a tax shelter the IRS is particularly interested in, for example, or the agency might decide to take a closer look at your return because it smells of the latest scam du jour identified by the IRS.

And there’s always the chance that someone has fingered you as a tax cheat. The IRS encourages such tips and even pays a bounty for leads that pay off in extra tax.