As tax season approaches, America’s thoughts turn to the required filing of income taxes. Theoretically, America’s tax system is a voluntary reporting system, however, that voluntary part is backed up by a pretty big stick, IRS audits.
Odds of Being Audited
According to IRS statistics, the chances of being audited by the IRS is about one in 100, or one percent. A deeper look, however, reveals the the IRS audits certain tax returns much more often than other returns. IRS audit statistics suggest that high-income taxpayers and those who own small businesses are more likely to be audited that middle and low income taxpayers who earn the majority of their income from wages and salary or brokerage-style investments.
The reasons certain groups get audited more than others are two-fold. First, and foremost, there is more money to be gained by auditing higher income taxpayers. For example, consider a middle income wage earner, who is married filing jointly, bringing down a salary of $70,000 with no other income. Taking the standard deduction for 2011, of $11,600 for married couples filing joint, that leaves $58,400 of taxable income.
Do the math and that taxpayer isn’t going to pay any more than around $7,500 and likely much less if there are any kids. Assuming that our fearless taxpayer files his income taxes and fudges a child care credit or student loan interest deduction, he might shave a few hundred bucks off his total. If he is caught and audited, then the IRS can recover that and penalties and interest (particularly if it is proven to be fraudulent). Either way, the sum total of collection by that IRS audit won’t be more than a $1,000. That’s hardly worth the time and effort.
Don’t get me wrong, the IRS can and does audit returns like this all the time, primarily to avoid the appearance of “never” auditing certain kinds of tax returns. All it takes is one person getting audited to scare-straight dozens of their friends and acquaintances. However, at the end of the day, this taxpayer isn’t really “worth” the cost of an audit.
Who Gets Audited By the IRS?
A high-income taxpayer on the other hand can generate a significant tax recovery. When someone’s total tax liability is $5,000, even a big cheater won’t owe too much extra if audited. However, when someone’s total tax liability is $25,000, $50,000 or more, a successful audit might recover $10,000 or more, especially if there are penalties and interest involved.
The other reason higher earning taxpayers get audited more often is that they have more ways to cheat. Someone who earns a salary and takes the standard deduction has very little room to be sneaky. After all, their salary is reported to the IRS as well as the taxpayer. Trying to cheat on that number is flat-out stupid, considering a computer will crosscheck each and every one of those.
On the other hand, higher salaried taxpayers tend to itemize their deductions. Many of those tax deductions, such as mortgage interest are also reported to the IRS and thus not likely to be underreported. However, there are plenty of deductions that can be exaggerated very easily. Catching these things is the bread and butter of audits.
For the same reason, small business owners are frequent audit targets. There are many deductions for small business owners and other than the requirement to keep receipts and records, many are completely undocumented directly to the IRS. The 2011 Section 179 tax deduction alone is worth up to $250,000 this year. That’s some real money worth collecting.
Tags: audit, filing taxes, income taxes, IRS, Taxes
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