Getting a letter in the mail from the Internal Revenue Service is not something many people look forward to. Usually it’s because they’re nervous about getting audited by the IRS. However, there are many misconceptions about what an audit truly is and who gets audited.
The IRS received a huge financial boost as part of the 2022 Inflation Reduction Act that gives the agency an additional $80 billion over the span of 10 years, which is projected to increase federal tax revenue by over $200 billion. More than half those funds will be directed toward enforcement, according to accounting firm PricewaterhouseCoopers, which says the IRS is expected “to substantially increase examinations of large corporations, partnerships and high-wealth individuals.”
We’ll explain the different kinds of audits the IRS sends, and who generally gets audited. For more tax tips, find out about common mistakes that can get you audited and tax breaks that can net you a bigger refund.
What is an audit?
There are three kinds of notifications that the IRS traditionally sends: adjustment letters, correspondent audits and examination audits.
Adjustment letters simply let taxpayers know they owe additional money or that there is a change in their refund amount, typically because of a miscalculation.
“People get a letter from the IRS and they automatically freak out and think it’s an audit, but it’s really just an adjustment letter,” TurboTax tax expert Lisa Greene-Lewis told CNET.
A correspondence audit is a bit more involved. It lets the taxpayer know additional documentation is needed to complete their return. The IRS might ask for receipts, bills, employment documents, canceled checks, legal papers, loan agreements, shareholder reports or even ticket stubs.
An examination audit is what people are really scared of, but less than 1% of Americans are audited in a given tax year, according to Jo Willetts, director of tax resources at Jackson Hewitt.
“Generally the IRS says ‘If you have the documents, send them to us,'” Willetts said. If you do receive a letter, she added, you might want to solicit a professional.
A face-to-face examination can take place in your home, your workplace, your lawyer’s office or at an IRS office.
When the audit is completed, the auditor will determine what’s required to rectify the situation. If you disagree with their assessment, there’s an appeals process.
Some of the issues that get flagged are no big deal, Willetts said, “and the IRS is not always right — or not fully right.”
In 2018, 30,000 of the million or so audits conducted resulted in taxpayers getting additional money back.
“It’s always a pleasure to resolve an issue with the IRS when it’s in the taxpayer’s favor,” Willetts added.
Who gets audited?
According to the General Accounting Office, audit rates have decreased among all income levels in recent years, in large part because of a lack of funding.
On average, the odds of being audited dropped from 0.9% in 2010 to 0.25% in 2019.
Errors or missing information on a return is the surest way to get a notice from the IRS. Audits can also be triggered randomly, or if your return is linked to someone else being audited, like an investor or business partner.
But higher-income earners can face increased scrutiny. The odds rise for those reporting income over $200,000 and, according to research from Syracuse University published in January, millionaires are the most likely to be audited out of any income bracket.
Declaring little or no income at all is a red flag, too, though. The audit rate for the lowest-income Americans was 1.27%, more than five times the national average.
“Lower-income audits are generally more automated, allowing [the] IRS to continue these audits even with fewer staff,” according to a GAO report from May 2022.
Taxpayers with incomes above $25,000 and below $500,000 have been audited the least in recent years, according to IRS data.
In August 2022, Treasury Secretary Janet Yellen said small businesses or households earning $400,000 or less a year “will not see an increase in the chances that they are audited.”
Danny Werfel, President Joe Biden’s nominee for IRS commissioner, reiterated that pledge in his Senate confirmation hearing in February.
IRS commissioner nominee Danny Werfel at his Senate Finance Committee nomination hearing.
Is there racial bias in who gets audited by the IRS?
Black taxpayers are disproportionately likely to be audited, according to a Stanford University report released in January. The research team found that Black taxpayers receive audit notices at least three times more often than non-Black taxpayers.
Depending on their income, household size and filing status, they may be as much as 4.7 times more likely to be audited.
Stanford law professor Daniel Ho, who led the research, said the disparity likely isn’t intentional but the result of cost-cutting measures and the secret algorithm governing the IRS’ audit selection methods.
Budget cuts have cost the agency more than 20% of its examiners over the past 10 or more years, according to Ho’s team, many of whom had the necessary expertise to investigate more complex tax issues. As a result, audit rates among higher tax brackets have declined while those for lower-income taxpayers haven’t.
The IRS is also leaning into correspondence audits, which are “easy to trigger, cost very little and require minimal effort by IRS personnel,” compared to in-person field audits, the researchers said. Some 70% percent of IRS audits are through the mail.
The researchers found the program the IRS uses to flag problems on returns and generate automated letters, the Dependent Database, tends to home in on errors involving eligibility for money back rather than on mistakes related to high-dollar amounts.
Half of all IRS audits, for example, involve taxpayers claiming the earned income tax credit.
According to Ho’s team, EITC-related audits are more likely to hit “lower-income individuals whose tax returns are less complex and less likely to lead to litigation.”
The program is also likely to target claimants with no business income because they are cheaper and easier to resolve.
Black taxpayers make up only 10% of EITC claimants reporting business income, the report found, but 20% of EITC claimants who do not.
“Racial disparities in income are well known, and what the IRS chooses to focus on has big implications for whether audits complement, or undercut, a progressive tax system,” Ho said in a statement.
These factors don’t account for the full disparity in who gets audited, the researchers said. Black taxpayers make up 21% of EITC claimants, for example, but were the focus of 43% of EITC-related audits.
The inconsistency persists regardless of gender, and marital or parental status, but is most pronounced among single Black men with dependents who claim the EITC. They’re nearly 20 times more likely to be audited as a non-Black couple filing jointly and claiming the same credit.
The researchers said they believe the IRS is also under pressure by lawmakers to go after individuals unduly receiving a refund over people committing tax evasion.
Filers claiming the EITC can receive a refund even if they paid no taxes that year.
“We’re not treating the dollar that is going toward the earned income tax credit as the same dollar that might be evaded by a high-income taxpayer,” Ho told USA Today. “If we treated those similarly, our evidence shows that the disparity would go down significantly.”
How far back can the IRS go to audit a return?
Generally, the IRS will include returns filed within the last three years in an audit, with most audits of returns from the last two.
“If we identify a substantial error, we may add additional years,” according to the agency’s website, which adds it doesn’t usually don’t go back more than the last six years.
If an audit is not resolved, the IRS may request extending the statute of limitations for assessing additional taxes and fees, which is usually three years after a return was due or was filed, whichever is later.
The auditee doesn’t have to agree to the extension of the statute of limitations date, according to the IRS. “However if you don’t agree, the auditor will be forced to make a determination based upon the information provided.”
How long should you hold onto tax records?
Since the IRS typically looks at returns from the past three years, it’s a good rule of thumb to hold onto your records for at least that long.
Six or seven years is fine if you really want to cover your bases, Willetts said.
The government has six years to claim revenue or start legal proceedings if your return included a “substantial understatement of income,” which, according to the American Bar Association, is at least 25% of your gross income. Although if the IRS makes the case you were intentionally committing tax fraud, that six-year deadline doesn’t apply.
