Every year we have clients asking us, what’s the chance of being audited by the IRS? And every year, our answer is pretty much the same. The chances of an audit are not very high, unless your return contains an item that the IRS has identified as a major area of taxpayer errors. Now, the new IRS annual data book for 2011, just released, supports that position.
Of the 140,837,499 total individual income tax returns with a filing requirement, 1,564,690 were audited, roughly 1.1%, which is the same as the rate for the previous year. An area that many individual filers make mistakes with is the Earned Income Tax Credit, or EITC. Consequently, of the total number of individual income tax returns audited in FY 2011, 30.9% were for returns with an EITC claim, a slight increase from the 30% of all audited returns for FY 2010.
Only 25% of the individual audits were conducted by revenue agents, tax compliance officers, tax examiners and revenue officer examiners. That’s higher than the 21.7% figure for the previous year. The 75% balance of the audits were correspondence audits, down from 77.1% for the previous year.
Following are selected audit rates for individuals not claiming the EITC, including those with business returns included, such as proprietorships or single member LLC’s, etc:
… For individuals with business returns other than farm returns showing total gross receipts of $100,000 to $200,000, 4.3% of returns were audited in FY 2011, down from 4.7% in FY 2010.
… For individuals with business returns other than farm returns showing total gross receipts of $200,000 or more, 3.8% of returns were audited in FY 2011, an increase from 3.3% in FY 2010.
… Of the individual returns showing farm (Schedule F) income, .6% were audited in FY 2011 versus .4% in FY 2010.
… For individual returns showing total positive income of $200,000 to $1 million, 3.2% of returns not showing business activity were audited, and 3.6% of returns showing business activity were audited. The audit rate for such returns was higher than the 2.5% and 2.9% respective rates for the previous year.
… For FY 2011, the audit rate for individual returns with total positive income of $1 million or more was 12.5%, close to forty nine percent higher than the 8.4% rate for FY 2010.
Not surprisingly, examination coverage increased for higher income earners. For example, the percentage was 1% for those returns with adjusted gross income (AGI) between $100,000 and $200,000 (up from .71% for FY 2010), and 2.66% for those with $200,000 to $500,000 of AGI (up from 1.92% for FY 2009). Exam coverage jumped to 11.8% for those with at least $1 million but less than $5 million of AGI (up from 6.67% for FY 2010). Similarly, coverage increased for those with at least $5 million but less than $10 million of AGI, as well as for those with AGI of $10 million or more.
These results indicate pretty clearly that for individuals, at least, the likelihood of being audited by the IRS on any given year is not very high. However, as your income increases, so does the likelihood of an audit. So for those with higher levels of income, including those with “flow-through” income, such as from partnerships or S Corporations, in which the business’ income is included on the owners/shareholders personal returns, this is an issue. Also, it’s sometimes a bit deceptive to look at just one year’s audit results. Generally speaking, the returns of any individual are subject to audit and adjustment by the IRS for three years. When a return is audited, it’s not at all uncommon for an auditor to ask for copies of all returns filed by the taxpayer that remain “open” to audit, to at least review them briefly, and if they determine it’s appropriate to open the examination on those years as well. So realistically, a better way to estimate your likelihood of an audit of any single year, is to add the likelihood of an audit for the most recent three years. Here’s an example.
Assume that an individual owns an S corporation, and has income that varies quite a bit from year to year, as a result of the swings in S corporation income shown on their return. So in 2009, the likelihood of an audit, based on the IRS, might have been 3.5%, in 2010 1.7%, and in 2011, 2.8%. Rather than look at the individual year’s chances of an audit, a more realistic way to understand the risk here, is to add the three numbers up, because of the three-year “open period” for any return. In this case, any of these returns probably has an 8% (3.5% plus 1.7% plus 2.8%) likelihood of being subjected to an audit, or roughly 1 in 12. Still long odds, but not as long as it would appear, if looking at only the annual results.
Our recommendation on this is that all taxpayers should approach their annual tax returns assuming that their return will be audited, but to be realistic that the odds of not being audited are still in their favor. We can discuss with any individual the specifis of their own returns that may increase the likelihood of an audit, but generally speaking, as you can see the likelihood, even when all open years are included, is still pretty small.
Next time, we’ll talk about business returns, and the likelihood of an audit there…definitely a different picture.