What Are Your Chances of Being Audited?

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The IRS has issued statistical data on its 2012 fiscal year activities.  This data provides valuable information about how many tax returns the IRS is likely to audit in future years, and what categories of returns the IRS will be focusing.  This data also provides insight into other IRS enforcement activities such as collections.  Overall there seems to be a slight downward trend in the percentage of returns being audited.

Percentage of Returns Audited.   Of the 144 million individual tax returns filed in 2011, less than 1.5 million, or about 1%, were audited in 2012. This is down from the prior year when 1.1% of the filed returns were audited in this period.   Of the total number of 2011 individual income tax returns that were audited in 2012, 487,408 (32.9%) were for returns claiming an earned income tax credit (EITC).  This was a small increase over the 483,574 (30.9%) of 2010 returns that were audited in 2011 for this reason.

Field Audits v. Correspondence Audits.  About 24.3% of the individual audits conducted in 2012 were field audits conducted by revenue agents, tax compliance officers, tax examiners and revenue officer examiners. That is a slight decrease from the prior year when 25% of the audits were field audits.  The 75.7% balance of the audits conducted in 2012 were correspondence audits.

Audit Risk Higher if Return includes Business Income.  For individual returns with business income other than farm income showing total gross receipts of $100,000 to $200,000, 3.6% of returns were audited in 2012, compared to 4.3% in 2011.  For returns with business income other than farm income showing total gross receipts of $200,000 or more, 3.4% of returns were audited in 2012, compared to 3.8% in 2011.  For returns showing farm income, 0.5% were audited in 2012 compared to 0.6% in 2011.

 Audit Risk Lower if No Business Activity.  For individual returns showing total income of $200,000 to $1 million, 2.8% of returns NOT showing any business activity were audited in 2012, while 3.7% of returns showing some business activity were audited in 2012.  In 2011, the rate of audit for such returns not showing any business activity was 3.2% compared to 3.6% for returns showing business activity.  In 2012, the audit rate for all returns with total income of $1 million or more was 12.1%, compared to 12.5% for 2011.  Business activity shown on a return includes any Schedule C business as well as claiming home office and similar deductions.

Audit Risk Increases as Income Increases.  The data clearly shows that the audit rate in 2012 increased for higher income earners. The audit rate in 2012 was 0.85% for returns with adjusted gross income (AGI) between $100,000 and $200,000 (down from 1% for 2011), and 1.96% for those with AGI of $200,000 to $500,000 (down from 2.66% for 2011). The audit rate increased to 8.9% for those with AGI of $1 million to $5 million (down from 11.8% for 2011). The audit rate for 2012 as compared to 2011 also increased for taxpayers with AGI of $5 million to $10 million, as well as for those with AGI of $10 million or more.

C Corporation Audit Rate.   For all corporate returns other than Form 1120S, the audit rate in 2012 was 1.5%, same as in 2011.  For C corporations with total assets of $250,000 to $1 million, the audit rate in 2012 was 1.7% vs. 1.6% in 2011.  For C corporations with total assets of $1–$5 million, the audit rate was 2.1% vs. 1.9% in 2011.  For C corporations with net assets of $5–10 million, the audit rate was 2.6% vs. 2.6% in 2011.  For C corporations with returns showing total assets of $10 million or more, the overall audit rate in 2012 was 17.8%, up slightly from 17.6% for 2011.  For larger C Corporations, the audit rate increased with the size of the entity.

Partnership and S Corporation Audit Risk.  The 2012 audit rate for partnership and S corporation returns was 0.5%, as compared to 0.4% for 2011.  The 2012 audit rate for partnerships and S corporations was well less than the rate for C corporations.

Summary.  The good news is that the risk of audit in almost all categories has at least temporarily decreased slightly.  Individuals claiming an earned income credit, however, significantly increase their risk of audit.  Individual returns that include business activity also increase the risk of audit.  The higher the reported income, the higher the audit risk as well.  The point of studying and reporting these statistics is not to scare you or convince you not to take an aggressive position on an item of income or expense on your return.  Rather, the point is to make you aware that audits do occur, that they occur more often in certain situations, and that you want to be in a position to defend yourself if you happen to be audited.  Contact me at 937-223-1130 or Jsenney@pselaw.com if you get audited or need some assistance dealing with a tax matter.

 AND ONE MORE THING.  Don’t forget, the American Tax Relief Act made several changes to the tax code that are short lived.  You need to act fast to take advantage of them. For example, the asset holding period for built-in-gains tax purposes is reduced from 10 years to 5 years for assets sold in 2012 or 2013.  Likewise, the small business stock gain exclusion is increased to 100% from 75% for stock acquired in 2012 or 2013.  If you would like to know more about the provisions of the American Tax Relief Act, contact me at 937-223-1130 or Jsenney@pselaw.com.