Why Tax Audits Aren't as Scary as They Seem (And Why You Should Claim Legitimate Deductions)
For many taxpayers, the idea of an IRS audit conjures up images of relentless scrutiny, mountains of paperwork, and stressful interactions with government officials. In reality, an audit is a straightforward process designed to ensure accuracy and fairness in the tax system. Understanding what an audit involves and how to approach your tax return can ease anxiety and save you money. Here’s why you shouldn’t fear an audit—and why you should always claim legitimate deductions.
What Is an Audit, Really?
An IRS audit is simply a review of your financial records and tax return to verify that everything is accurate and complies with tax laws. The IRS conducts audits in three primary ways:
Correspondence Audit: The most common type of audit, conducted via mail. It typically focuses on specific issues, such as verifying a deduction or income item.
Office Audit: Conducted at a local IRS office. These audits are more in-depth but are still focused on particular concerns.
Field Audit: The least common and most comprehensive, where an auditor visits your home, business, or accountant’s office.
In most cases, audits are not about catching fraud or wrongdoing. They’re about clarifying discrepancies or confirming eligibility for deductions.
Why Taking Legitimate Deductions Is Important
Some taxpayers avoid claiming deductions they’re entitled to, fearing that it might trigger an audit. This approach, however, is not only costly but also unnecessary. Tax laws are designed to provide relief where it’s due, and taking legitimate deductions ensures you’re not overpaying.
For example:
Business Expenses: If you’re self-employed, deductions for things like home office use, supplies, and travel can significantly reduce your taxable income.
Charitable Donations: Contributions to qualifying organizations are tax-deductible and encourage giving back to the community.
Education Credits: Tax credits for tuition and educational expenses can make higher education more affordable.
Claiming these deductions can result in substantial savings, which is exactly what they’re intended to do. Avoiding them out of fear of an audit is like leaving free money on the table.
What Is the Likelihood of Being Audited?
The likelihood of an IRS audit varies based on income levels and other factors. In recent years, overall audit rates have declined, with the average rate dropping from about 0.9% in 2010 to 0.25% in 2019.
Audit Rates by Income Level:
Low-Income Taxpayers: Individuals earning less than $25,000, particularly those claiming the Earned Income Tax Credit (EITC), have experienced higher audit rates. In 2021, this group faced an audit rate of approximately 1.27%, which is more than five times the overall average audit rate.
Middle-Income Taxpayers: Audit rates for individuals earning between $25,000 and $200,000 have been relatively low, generally ranging from 0.1% to 0.2%.
High-Income Taxpayers: Higher-income individuals have historically faced greater scrutiny. For instance, taxpayers with incomes between $1 million and $5 million had an audit rate of 1.3% for tax year 2019, while those earning over $10 million experienced an audit rate of 8.7%.
Factors Influencing Audit Probability:
Income Level: Higher incomes can attract more attention due to the complexity and potential for larger discrepancies in returns.
Claiming Certain Credits: Utilizing credits like the EITC may increase audit likelihood, especially if documentation is lacking.
Unusual Deductions or Discrepancies: Significant deviations from typical filing patterns can trigger audits.
What Happens If You’re Audited?
If your return is selected for an audit, here’s what to expect:
Clear Communication: The IRS will notify you by mail, detailing what they need and why.
Opportunity to Respond: You’ll have time to gather documentation, such as receipts, bank statements, or prior tax returns.
Resolution: After reviewing your materials, the IRS will either agree with your return, propose adjustments, or provide an opportunity to dispute their findings.
With proper documentation and honest reporting, most audits are resolved without issue. In fact, many audits result in no changes to the taxpayer’s return.
I Was Audited This Year
I installed solar panels on my home in 2022, and when I filed my taxes in 2023, I claimed a credit for that. Earlier this year I received notice of a correspondence audit, meaning they sent a letter asking me to substantiate my solar purchase. I gathered my paperwork, which consisted of my invoice, site designs, permits, contract for purchase, and photos the installers had taken.
During this process, I realized that I had only claimed a credit for the original purchase price, but during the install process, they realized they could fit a couple more panels on my roof, so I opted to purchase, those, too. When I claimed the credit on my taxes, I had only claimed the smaller amount.
I responded to the IRS with evidence that I had installed solar, and in the last six months since my response, I have gotten two letters letting me know that they still haven’t gotten to my response but would review it when they could. I am not worried at all. I assume within a few months I will receive notice that all is good.
I am also amending my tax returns to reflect the larger amount of the solar purchase. Which means the audit will have actually resulted in me receiving more money!
Tips for Peace of Mind
Keep Good Records: Maintain receipts, statements, and documentation for all deductions and income.
File Accurately: Double-check your return or consider using tax software or a professional preparer.
Know Your Rights: You have the right to representation and to appeal any decisions you disagree with.
The Bottom Line
Avoiding legitimate tax deductions to sidestep an audit is like avoiding medical checkups to sidestep a diagnosis—it may feel safer in the short term but can cost you in the long run. Audits are rare, and they’re usually straightforward when approached with honesty and preparation. By claiming all the deductions you’re entitled to, you’ll reduce your tax burden and maximize your financial health. Remember, the tax code exists to help you as much as it exists to ensure compliance. Embrace it, and don’t let the fear of an audit hold you back.