Will You Get Audited by the IRS?

Four reasons why the IRS might take a closer look at your tax return.

By SHARE

Who loves the IRS? Probably very few of us.

The numbers probably diminish when you start asking the folks who have undergone an IRS audit. I've been audited twice (the easy paper variety) and I still appreciate the IRS (love might be too strong a word), but my tune would probably change on a full-fledged audit with a revenue agent.

[See 50 Ways to Improve Your Finances in 2012.]

It's easy to cast the IRS as the villain, a heartless entity seeking to punish honest hardworking people, but at the end of the day, the IRS is concerned about one thing: generating revenue. They don't make the tax laws; they simply enforce and collect on them. With all the political talk about debts and deficits, you'd think more politicians would laud the IRS for their efforts to more accurately collect tax revenue ... right?

Our tax system is heavily based on honesty. Despite the rise in electronic and paper trails, a lot of our transactions are still conducted without any written record whatsoever. When you buy something at the local bagel shop with cash, that money may or may not be recognized when the shop does its taxes. The tip you leave for that nice waiter or waitress might not be recognized. So the IRS has a difficult task of trying to accurately collect tax revenue, and audits are just one of the mechanisms it uses.

[See 12 Money Mistakes Almost Everyone Makes.]

Audits are, for the most part, not random. The IRS published a page back in 2006 that explained how it chooses which tax returns to audit. it comes down to four categories:

Computer Scoring: The IRS uses two scoring functions to calculate the likelihood that you under-reported income, based on models it has built using historical data. This alone doesn't determine whether you will get audited, but a higher score on either function means you're more likely to be examined (the polite word for audited.)

Information Matching: Since the IRS gets your W-2s and 1099s, it can match them with your return to see if the numbers add up. A mismatch will trigger an audit, usually a CP2000 paper audit.

Relationship-Based: If you have a relationship with someone, usually a company, that is audited, you might be audited as well. For example, let's say someone paid you and issued a 1099-MISC, but their return was audited. You might face an audit because you were issued a 1099-MISC.

Participating in Tax Avoidance: This is a version of the relationship-based case, but one that bears separate discussion because it's becoming more and more common as enforcement picks up. An example is the recent Justice Department case against Swiss bank Wegelin & Co. that charged three bankers with tax fraud. You might be audited if you have an account at the bank.

[See 4 Smart Ways to Spend Your Tax Refund.]

In my case, both audits were the result of information-matching. In the first case, I never received a 1099-INT from an online bank and the penalty was a few dollars of interest. In the second case, information on a 1099-MISC was included on a corporate tax return and then reflected on a Schedule K-1, but the IRS expected it to be on a Schedule C, so there was no net additional tax there.

In both cases, it wasn't the IRS being mean... they were simply doing their job.

Jim Wang writes about personal finance at Bargaineering.com. When he's not tackling money issues, he's usually looking forward to his next vacation and writing about it at Wanderlust Journey.