An unexpected letter from the Internal Revenue Service can make your stomach drop, but you can take steps to reduce your audit risk.
Taxpayers overall face a low audit risk: The IRS audited 1.1% of all individual tax returns filed in 2010, or 1.6 million returns of 141 million filed.
The vast majority of those audits — 1.2 million — were done by mail. Just 392,000 involved an in-person meeting with the IRS. That’s not necessarily good news. Taxpayers often are confused by IRS correspondence and with such audits don’t have the benefit of working with one single agent, the National Taxpayer Advocate says.
Schedule C
Sole proprietors filing a Schedule C can reduce their audit risk by sticking to the facts — or at least making sure their expenses and income are not dramatically different from similar businesses.
For example, one Chicago-based hot-dog-stand owner said his cost of goods sold was 50% of gross receipts, said Robert McKenzie, a partner in the law firm Arnstein & Lehr. “I know Chicago hot dogs are great, but he had a high cost.”
The IRS found the hot-dog salesman was reporting his expenses but only part of his revenue. He faced “a lot of tax and penalty,” McKenzie said.