Some people have a greater chance of dying in an automobile accident than going through an IRS tax audit. Depending on your gross income and the type of expenses you incur, your chances of an IRS audit can be much higher. However, if you fill out your tax return honestly and take some proactive measures, you have nothing to fear even if the IRS selects you for an audit.
The actual audit rate varies from year to year, but the IRS usually audits about 1 percent of all returns. In 2010, the IRS audited 1.11 percent of taxpayer returns, according Richard Rubin of "BusinessWeek." Audit rates vary by income and which deductions you claim. In general, as you earn more money your audit risk increases. The IRS breaks down most of its audit statistics in its annual Data Book.
The IRS reviews information on thousands of returns to determine which deductions and income levels increase the chance that someone makes a mistake on their return or possibly commits fraud, and puts it into a formula called Discriminant Function, or DIF. The self-employed, for instance, often omit income and are a huge contributor to the $290 billion in unreported income each year. If you have a job and file Schedule C for business expenses, especially at a loss, the IRS is likely to rate you a higher audit risk. If you make between $5 million and $10 million, you had an 11.6 percent of an audit in 2010, according to Rubin.
Lowering Audit Risk
Anything unusual draws the attention of the IRS. For instance, if you have a large amount of itemizing deductions for your income, such as claiming $50,000 in expenses when you make $60,000 a year, you have a good chance at an audit. Working in an industry where cash is common, such as waiting tables, automatically raises your DIF score, so you should keep receipts for purchases and report tips accurately. Review any tax forms, especially 1099s and list the exact amounts on your taxes, because unreported income is a huge red flag.
Although you never want an IRS audit because of the inconvenience alone, you should not avoid taking a deduction because you think it may lower your audit risk if you can prove you deserve it. However, you must have receipts or other documentary evidence of your expenses. If the IRS audits you and you cannot substantiate a claim, it will likely nullify it and impose penalties. Consider going to a tax professional, because they have data on the typical size of deductions for taxpayers in your region.