Surprisingly good news about IRS audits.

What the Odds Are That Your Tax Return Will Be Audited, and What to Do If It Is

Overall, the odds are reassuring. The vast majority (99%, in fact) of individual income tax returns skate safely past the IRS audit machine. Better news: The 1-in-100 chance of being called on the carpet really overstates the severity of the situation. Fully 70% of all audits are handled by mail, not by mano a mano combat with an IRS agent. And, if your return doesn’t include income from a business, rental real estate or a farm, or employee business expense write-offs, the basic 1-in-100 chance of being challenged jumps to 1-in-250.

Another piece of rarely reported good news: Each year, tens of thousands of taxpayers walk out of an audit with a check from the government. In 2011, for example, 66,381 audits resulted in refunds totaling over $1 billion. [TOOL: Calculate Your Risk of an IRS Audit] The 1-in-91 chance of being audited is the overall average. Your actual odds turn on the kind of return you file and the type of income you report. Our calculator, based on official IRS data on returns audited in 2012, will give you a good idea of the odds that your personal 1040 (or 1040-A or 1040-EZ) will be selected for review — either by mail or in person. And, remember, even if it is, there’s a 1-in-7 chance you’ll walk away unscathed or be one of the lucky ones whose audit results in a refund.

With few exceptions, of course, the IRS doesn’t randomly choose which returns to audit. The few thousand random reviews each year are performed to help the IRS calibrate the computers that identify the juiciest targets. Over the next few months, the IRS will be plugging data from more than 140 million tax returns into a computer that scrutinizes the numbers every which way and ponders how the picture you paint of your financial life jibes with what it knows about other taxpayers. The computer tries to spot returns that are most likely to produce extra tax if put through the audit wringer. The computer’s choices are reviewed by a human being who can overrule them if, for example, an attachment to your return satisfactorily explains the entry that set the computer all atwitter. Short of such a veto, your name will go on the list. Even if your return survives the computer’s scrutiny, you’re not necessarily safe. You may have listed an investment in a tax shelter the IRS is particularly interested in, for example, or the agency might decide to take a closer look at your return because it smells of the latest scam du jour identified by the IRS. And there’s always the chance that someone has fingered you as a tax cheat. The IRS encourages such tips and even pays a bounty for leads that pay off in extra tax.

Don’t Panic Whatever the reason you’re chosen for an audit, it’s chilling to get the word that the IRS wants to examine your return. After all, everyone knows that the IRS was able to do what J. Edgar Hoover and all the G-men of the FBI couldn’t do: put Al Capone behind bars. Even if you have no reason to think you did anything wrong, you can’t escape the anxiety that accompanies an audit notice. For one thing, the return being audited is unlikely to be the one you just filed. A lot of taxpayers are only now hearing from the IRS about their 2011 returns … and some 2010 returns are just coming up to bat. (Generally, the IRS has three years from the due date of your return — until April 15, 2016, for 2012 returns — to initiate an audit.)

How It All Begins You’ll get a letter announcing your fate. The simplest audit — a correspondence audit — requires only that you mail in the records needed to verify a specified claim on your return. In a field audit, an IRS agent comes to your home or place of business to go over your records. Most common, though, are office audits, which involve getting yourself to a local IRS office. You’ll probably have at least a couple of weeks to prepare. If the appointment is set for an inconvenient time or you find that you’ll need extra time to pull your records together, call the IRS promptly to request that the audit be rescheduled. [More from Kiplinger: 12 IRS Audit Red Flags] The written notice will identify the items on your return that are being questioned — usually such broad categories as employee business expenses or casualty losses — and outline the types of records you’ll need to clear up the matter.

Office audits are usually limited to two or three issues, so you won’t be expected to haul in all your records. What kind of evidence do you need? Here’s how a retired IRS official with 30 years of auditing experience answered that question: “I expect to see the records you used when you prepared the tax return. You must have had some. Otherwise, how did you know you gave $5,000 to charity?” Also, beware that auditors are sometimes looking for more than proof of what’s on your return. They’re also interested in whether income that should have been reported was left off. That could mean a review of your bank records, for instance, in search of deposits that might represent unreported income.

Audit Yourself The best way to begin preparing for your meeting is to pull out your copy of the return being audited. Before the IRS puts your forms to the test, do the job yourself. Pore over the items being questioned and pull together the documents that support your entries. Of course there will be gaps, but don’t automatically concede defeat. Try to reconstruct missing records.

  • If, as luck would have it, you can’t find the return, call the IRS office that contacted you and ask how to get a copy.
  • Get copies of canceled checks from the bank or duplicates of receipts or written statements from individuals who can back up your claims.
  • If you can’t come up with written evidence for certain entries, prepare an oral explanation.

Your records needn’t be perfect. If you can reasonably explain how you came up with a figure that’s not fully corroborated by the evidence, the IRS may well accept it. The IRS likes to stress how reasonable audit personnel are. However, when you’re pulling together your records, remember this: The more thorough your documentation is in general, the more likely an auditor will cut you some slack on an occasional point. Reprinted from Kiplinger