Understanding Your Odds with IRS Audit Technique Guides

Many taxpayers fear that aggressive deductions wave flags in front of IRS auditors and quite often I am asked what the chances are of being audited as if my opinion is some sort of a benchmark. The fact of the matter is that every tax return electronically filed is subject to some form of matching protocol, inspection, examination or audit.

Today’s historically connected engagement electronically between the US Government and its citizens has eroded privacy by subjecting us all to some form of unnoticed scrutiny. But at the same time incremental audit rates of substance seem to have proportionally decreased which mean that any particular taxpayer’s odds of attracting attention are slim unless you are a complete moron or behaving overtly fraudulent. Basically the simple answer is that if you properly documented legitimate deductions, you have little to fear.

If however you want to know how aggressive you can get I suggest referring to the IRS’ own audit techniques guides for over 50 specific industries from Alaskan commercial fishermen to pizza restaurants and coin-operated laundries.

Keep in mind that penalties are essentially assessed based on whether you have a “reasonable” basis for taking a position which is loosely defined as more than one chance in three of being accepted by the IRS. In fact if the audit technique guides and the Internal Revenue Code prove inconclusive and you remain concerned you can still file the claim and protect yourself somewhat by filing IRS Form 8275 or IRS Form 8275-R to disclose positions you believe to be contrary to law or regulations. Beware though as these forms tend to attract scrutiny.

Historically audits peaked in 1972 at one out of every 44 returns. As of 2012, the rate has dropped to one out of every 100.1Roughly half focused on a single issue: the Earned Income Tax Credit claimed by roughly one in seven filers. The IRS focuses the rest of its efforts on three main targets:

1. Small businesses, particularly sole proprietors operating cash businesses, who underreport income and skim receipts. (These make up the bulk of audit targets.)
2. Individual taxpayers who fail to report pass-through income from partnerships, limited liability companies, S corporations, trusts, and estates. (In 2002, the IRS launched a program matching income from those sources to recipients.)
3. Phony trusts, churches, home-based businesses, and similar frauds and protests.2 (These account for most tax prosecutions – and while the IRS has lost a couple of high-profile criminal prosecutions, no court has upheld any of these theories.)

The table below, taken from the 2010-2012 IRS Data Books, summarizes audit data for those years: