The IRS Audit Lottery

Face it, the odds of winning the lottery, power ball or whatever it may be called are probably only slightly less then being hit by lightning on an absolutely clear winter evening. Twice. The odds of winning the IRS lottery are better. But not as good as you may think. Tax returns are not selected by random. Au contraire. The IRS does its best to use its limited resources laser like to select those returns which most likely present compliance issues. As computers become ever more sophisticated the process becomes more fine tuned. For the most part, audit selection is based upon the entries on the return. In a well kept IRS secret, a formula exists which when pumped into the IRS computers spits out tax returns which should at least be reviewed by a human and possibly further examined by the IRS examination division. Now as to the odds themselves: there are about 140 million individual income tax returns filed annually about 1.5 million are audited. That is approximately 1.1%. Most of these audits are conducted by correspondence. That is, lucky winners get mail from the IRS requesting explanation and verification of tax return entries. For business returns showing total gross receipts of $100,000-$200,000 approximately 4% are audited and for those returns with receipts of $200,000 or more 3.8% get to chat with IRS. For lucky winners with total positive income of 1 million or more, the rate may be as high as 12.5%. In all categories for recent years IRS claims that audit rates have increased slightly. How does one avoid winning this lottery? Recognize that the deductions, credits and allowances claimed on a tax return are actually compared to income and that the IRS formula also considers the likelihood of being able to survive on the amount of net reported income. IRS does also conduct special audit projects to identify non filers and problem cases and the agency may respond to hate mail from disgruntled spouses, employees and such. IRS has also gotten rather good at matching those pesky forms 1099 that are sent to taxpayers every year by all manner of income sources. Brokerage houses for example will be letting IRS know not only the gross sale proceeds of stock sold but also the tax basis or cost that is used to figure the taxable gain on the transaction.

Italian tax authorities have shifted their attention away from tax return numbers on their forms and toward finding out what Italians spend and then comparing that to their filed tax return. How did Mario have the lira to get that Maserati on the paltry income reported on his not so buono Italian tax return? As computers, iPhones, iPads and such track a taxpayer’s every purchase and preference, hiding from IRS or the Italian tax people for that matter, may become very difficult indeed.