Over the years, I have spent a fair amount of effort trying to get my readers to spend less time and money in fear of a tax audit. While an audit is never going to be fun and may cost you a lot of time and even money, the truth is that tax audits are pretty uncommon and becoming less and less common all the time.
For example, the IRS only audited 0.5% of tax returns filed in 2017. There is a higher audit rate for high earners, about 3% for those with $1M+ in income, but still not something to spend a lot of time lying awake at night worrying about, much less not taking legitimate deductions and credits that you should take because you fear they will trigger an audit. Most of the audits are “correspondence” audits, not “field” audits too. So it just means mailing some forms in or having your tax preparer do so.
However, the IRS is not the only entity that does tax return audits. States can also do audits, and the more states you file in, the more likely you are to be audited. I had one this year from the State of Utah. It was a “correspondence” audit, where they basically asked for some more information. The Utah Statute of Limitations on audits is 3 years from the later of the due date or the date the return was actually filed. This audit showed up 25 months after the return was filed. Here's what the letter looked like:
That's right. Utah audited me over $50. How this is worth their employee's time, much less my time, is completely beyond me. $50 represents less than 0.1% of the tax I paid Utah for 2017.
When I read the letter, I had some recollection of dealing with this issue when I filed the return a couple of years previously. So I logged into my UESP (now My529) account to look at the form they sent the state tax commission. Here it is:
As you can see in the upper right hand corner, this is the corrected form that the auditor is asking for. Now, whether UESP never sent the form or whether the state tax commission lost it, I have no idea. But I really don't care. The auditor was kind enough to leave his email address, so the next morning between patients I emailed it to him with this message:
I think we spent more time riding this wake than on my tax audit.
I received your audit letter.
Letter ID: ——–, Account ID ——–, Period Dec 2017
I'll try to call you in a couple of hours when you open, but I am attaching the documentation you should need to clear this up. The UESP form was corrected 3 years ago but either they never sent it to you or it was never entered in properly, triggering the audit.
Less than 3 hours later, he emailed back:
I appreciate you sending in this information to verify your UESP credit. I don't believe we will need anything else at this time.
Thank you
And the audit was over.
- Total time spent by me on it: 5 minutes
- Total money spent by me on it: $0
- Most audits are correspondence audits just looking for more information.
- Most audits are triggered automatically by a mismatch between information provided by an outside reporting entity (on a W-2, a 1099, or in my case, a TC-675H) that differs from what you put on your return. Make sure all that stuff matches perfectly, but don't worry as much about the stuff that only you report.
- In many cases, you did nothing wrong. The IRS reports that 29% of the time on returns for those with an income of $1M+ there is no additional tax due as a result of the audit. Although to be fair, on average they collect $62K (correspondence) to $143K (field) from these very high earners. Those numbers are 21%, $24K, and $32K for those with a more typical doctor income of $200K-$1M.
- Audits need not be long, drawn-out affairs requiring endless amounts of time.
- An audit may cost you nothing.
- You may not need professional assistance with an audit.
What do you think? Have you been audited? Was it federal or a state? What was your experience like? How much time did you spend on it? Was it their error or yours? How much did you end up paying? Did you handle it or your tax preparer? What did you learn from the experience? Comment below!
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I have been audited by my states unemployment commission. I ended up paying them $40. It did freak me out when I got the letter. I had not been considering infrequent fill-in nurses as anything other than 1099 employees. Not so according to me state auditor. They need unemployment taxes paid as well as a W2.
I own a dental practice and I was audited by my state’s unemployment commission. I live in a state – Connecticut – with chronic fiscal mismanagement – which does not help. After a 3-4 hour long visit, they determined that I should have been paying unemployment for my 2 kids who are on my payroll. I pay each of my kids as models $1000 per year as W-2 employees. The amount owed was small but with “penalties” the whole thing cost me over $400 and I lost 3-4 hours of time I could have been spent seeing patients.
I can only believe that when Covid is over, States will be DESPERATE for money, and audits like these will only increase.
I learned major lessons when my 2009 federal tax return was audited in person in 2011.
Most important: my paper filing system was grossly inadequate.
The IRS requested every bit of information: 3 years of bank, investment, and credit card statements.
All charitable receipts, and 3 year of tax returns, even though they already had them. All this took hours.
The IRS agent was courteous and professional, He would not accept even a cup of coffee or a bottled water.
He actually found a $250 deduction that I had missed.
I ended up paying $1000 because Fidelity made an error in reporting the basis in the sale of shares of Cedar Fair.
From that point forward, I kept all records in digital files.
Many of my weekly and monthly donations, such as church donations, were switched to Fidelity Charitable DAF.
Every one-time donation is now given electronically, and the receipt stored. All taxes are paid electronically.
No more check writing–I learned that some of the charities had not sent written confirmation of checks, entailing phone calls and email.
No more paper records. What else is new? Does anybody still keep paper medical records?
I switched to TurboTax. Now all bank and investment records are downloaded directly into the return.
I guess I had to learn the hard way about financial record keeping.
Now, tax time is a breeze. And I am prepared if another audit comes. I hope not.
Agreed. I’m not sure why anyone is still keeping paper records, but it seems plenty of people do it. I’ve been keeping everything electronically since I started filing in 2002. Never been audited, but this is one reason I’m not worried about it. I only keep the paper I absolutely have to (birth certificates, etc). Quicken helps with receipts too.
I guess then I have been audited once by my state and maybe five or more times by the IRS, all paper audits. I think the state needed proof that our goofy income, with husband’s retirement pay not taxable here, was as stated.
The IRS kindly catches the numerous math mistakes I have made over decades of filing. On another occasion, they were not accepting my statement of a basis for a stock sale / transfer. My letter explaining it was adequate. Probably also included copies of 10 to 20 year-old purchase price statements.
About half the time they tell me there’s an error in my favor and send me a $20 to $400 refund. And of course on two or three occasions I have pre-empted an audit by apologizing for some error I realized a few months or a few years later, and have never been penalized for late filing of 8606s etc. Often find myself doing an annualized income 2210 since those year end capital gains statements can be a pretty sizable part of our income. Now I try to forestall that, this year with excessive deductions on a salary, but next year after I retire I will probably be doing AI again. Pay pretty close attention to my taxes after quarterly payments which for two or three years in a row always seem to end up with me getting a big refund anyway. Have decided late fees and interest are worth waiting on those February March statements from brokerage companies.
Funnily enough the few years I was paying and earning in both England and in the US they never audited me. One year I got three different figures for my US taxes owed and chose to pay the middle number. And totally ignored the school fundraising auction accountant service (another parent) doing my British taxes and claiming all sorts of deductions that aren’t kosher in the US. Just as in medicine, if I can’t understand it or believe it I don’t go with that choice.
I sold my primary residence shortly after getting married. While I qualified for the full $250k capital gains exclusion, my wife had only lived in the house for 4 months so, following the law, I only claimed 4/24 of the exclusion for her. New York audited me and, since I could not prove that she moved in (basically they wanted to see a receipt from a moving company and I had none), they disallowed her cap gains exclusion (but were happy to collect her taxes as a resident). The interesting thing was after it was settled and the check was written, the auditor told me that the flag for the audit was that I had claimed only part of the cap gains exclusion, and not the whole thing. Had I not scrupulously followed the law, I never would have been audited. Lesson learned.
My wife was audited by the IRS for her federal return a few years ago. They thought she owed an extra $2500 which freaked us out a bit. Turns out she paid her college tuition bill in December for the following Spring semester so it showed in their system that she didn’t have any college expenses to claim the $2500 education credit. We got the university to write a letter to explain the situation and got it sorted out. We probably spent a few hours total. I think they even found that they owed us an extra $75. All in all besides the initial shock, it wasn’t a bad experience.
Thanks for sharing, Jim and other commenters.
It would appear that an unspoken benefit of a income tax-free state is half the chances of an audit…even if it is 5 min.
I’ve represented dozens of clients on audits. It’s true the odds of getting audited are small, and if you’re a W-2 employee probably pretty painless. The mismatch notices are very common and usually easy to deal with. In general, doctors are good rule followers and decent record keepers and if that’s true for you you’ll have less to worry about.
However, if the IRS does a full audit on you it can be pretty painful and expensive to defend against. The IRS wins about 85 percent of the time and the penalties and interest on the adjustments can be substaintial.
If you are self employed it is important to color within the lines on your expenses, and make sure your tax return jives with your bank statements. The first thing the IRS will want to see is your bank statements, and they will assume every penny deposited is income, and that most claimed expenses are overstated, leaving you with the burden of proof that it isn’t.
So I wouldn’t worry about an audit, but file with the assumption you will get audited, and if you take any aggressive positions, make sure you have thought about your legal rational. The standard is that you are more likely than not correct., it doesn’t need to be beyond a reasonable doubt.
Not sure what you mean by “win” but if you only end up paying $200 in extra taxes it’s hard to call that a big loss even if the IRS counts it as a win.
When I say the IRS wins audits 85 percent of the time, I’m talking about an audit with an IRS Revenue Office assigned to the case that generates a Form 4649-A, Income Tax Examination Changes to the taxpayer, where the changes are to the detriment of the taxpayer. In these audits they want to see bank statements and proof of expenses. I don’t count IRS automated collection systerm (ACS) notices as an audit., those are just routine notices – they send out millions of those.
Right. But what’s a win? If I pay a $1 in additional tax to them is that a win? Not really. It’s basically confirmation that my return was fine. $100? Same thing? $1000? Same thing. $10,000? Same thing at my income level. But I bet they would all count as a “win” in your 85% statistic.
I have had numerous paper audits from the IRS and when I tried settling them myself it’s like pulling teeth- there is no e-mail contact and I am on hold for hours. Having my accountant take care of this is worth it’s weight in gold. The most ridiculous IRS audit I have ever gotten was paying my tax for the year and getting an audit notice saying that my payment didn’t count, even though they had withdrawn the money from my account!!! My accountant had never seen that before, but it seems because my wife and I have different last names the tax bill only got applied to her name, not mine, despite us filing jointly.
When I first started doing my own taxes, particularly the corporate ones, I was audited a handful of times. IRS has been very helpful each and every time clearing things up. Not once have I owed them additional funds and on two occasions I received a small refund once for $12 and another for $42.
Unless one is trying to avoid taxes (ala Wesley Snipes,) the IRS understands we are human, we make mistakes, and are not trying to crush us to throw us in prison.
WCI, how much extra weight in that boat beside the ballasts? I am getting wavemakers upgraded ballast for mine. Looks like you are about to loose it.
Wakemakers is great. I’ve got 3400 lbs plus the wedge, plus 200 steel in the bow plus walking ballast. Yea, it’s tough to surf two at a time.
Audited by Utah over a year ago as well. They asked for my tax return for another state I filed in as well as a verification form for a deduction that I took, which I did not have, and I told them I did not have it ( I did not know I needed it, chalked it up to doing my own taxes). I expected them to send me a bill for the tax that I did not pay and admitted that I did not have verification to support that deduction. It would not have been much, $50 at most. They told me that they would get in contact with me if anything else was needed, and I still haven’t heard anything. Over a year has gone by and I still haven’t heard anything.
Interesting.
I am audited annually because the IRS does not recognize the QCD on my form 1040 and try to assess tax on the amount of the QCD.
Bizarre. My parents do QCDs, no audits yet.