It’s a taxpayer’s worst nightmare: the letter in the mail from the Internal Revenue Service.
“It creates a lot of anxiety,” said Bob Meighan, a vice president at TurboTax, the tax preparation software.
Sometimes the mailed notices are benign: You forgot to sign your return, or the IRS recalculated your entries and found that you made a math error and are due a refund. But the more ominous ones question income, deductions or some other entry.
The IRS defines an audit as “a review-examination” of a return “to verify the amount of tax reported is accurate.” If you are selected for one, the agency has on its website a video guide to the process.
In 2011, the IRS audited nearly 1.6 million individual returns, slightly more than 1 percent of the total filed. About three-quarters were done by correspondence, the rest through field examinations done in person by an IRS agent.
Only 1 percent of people with incomes under $200,000 had their returns audited; the audit rate for those with incomes of $1 million and higher was about 12.5 percent.
IRS spokesman Terry Lemons said the vast majority of taxpayers fill out their returns accurately and have nothing to be concerned about.
“We have a variety of screening processes to make sure we catch the people who are cutting corners,” he said.
So how does the IRS select which returns to audit?
“There’s no magic equation,” said Mark Steber, chief tax officer for Jackson Hewitt Tax Services.
Some returns are selected for audit through computer screening. An IRS computer “basically compares data from (McGraw-Hill, 2011) your return to average numbers from people in similar situations and they look for variances,” said Jeff Schnepper, author of “How to Pay Zero Taxes” (McGraw-Hill, 2011).
“They look for big changes, things that shouldn’t be there,” he said.
What’s reviewed are things like charitable contributions, interest income, and whether there are variations from averages in your income bracket or zip code. “Every time there’s a major variance, the computer is going to click,” he said.
Others are selected randomly, and still another group is selected by document matching to see if forms like the W-2 match what was reported on your income tax return.
There’s yet another category — “related examinations,” the IRS calls it. “Returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit. “
The agency will notify taxpayers of an impending audit by telephone or mail. E-mail is not used, the agency said.
“Just because your return has been selected for an audit doesn’t suggest you made an error or you’re dishonest,” the IRS says in its video guide. “It might surprise you to know that audits can result in acceptance of the tax return without change or even a refund.”
The IRS has a Declaration of Taxpayer Rights that sets forth what you can expect from an audit, ranging from privacy and confidentiality to professional and courteous service. Taxpayers have the right to representation at an audit or to have someone else represent them, and to make an audio recording of the session. They may appeal the judgment, either to the Appeals Office or to a court, and can request that penalties and interest be waived.
Accuracy is the best defense in an audit — and having the records to confirm it. Lemons said using tax preparation software and filing electronically can help catch some common mistakes.
“It’s important that you do things accurately, and you think through those items reported by third parties and make sure those are going to match up,” said Greg Rosica, tax partner at Ernst & Young accounting firm.
He advises paying attention to the simple things — like correctly reporting your Social Security number or the number of dependents.
“If you’ve gone through and you have a well-organized file, there’s not so much to be worried about,” he said.
Steber said that claiming deductions for a home office likely will attract IRS scrutiny.
As for charitable contributions, he said there’s no particular amount likely to catch the IRS’ attention.
“Don’t shortchange yourself,” he said. Find out what donated items sell for, at a thrift store, for example, or check valuation tools on the Internet. “It’s all in the documentation,” he said.
Schnepper said the IRS sometimes focuses on taxpayers with cash earnings, like waiters and waitresses. “The IRS is looking for unreported income,” he said.
It’s important to keep the records you’ve used to file your returns for at least three years. Generally that’s the time frame in which the IRS can conduct an audit.
“The name of the game with the IRS is paper,” Schnepper said. “Keep your records. Keep your receipts. If you have your receipts, you win.”
IRS video guide to audits: www.irsvideos.gov/audit
IRS audit statistics: http://www.irs.gov/pub/newsroom/fy_2011_enforcement_results_table.pdf
Carole Feldman can be followed on Twitter at: http://Twitter.com/CaroleFeldman