5 Things You Need to Know About the IRS Audit Process

There are a bunch of things that worry us this time of year: racing home from work in time to make our kids' baseball games, finding the best meds to ward off those annoying spring allergies and doing everything possible to avoid a tax return audit.

But when our President Trump is audited basically annually and nothing seems to come out of it, people often surmise that if he can get away with it, we should be able to as well.

The good news is that thanks to serious budget cuts, there isn't enough man power to send someone knocking on your door. 

The bad news is the IRS still uses a bunch of matching systems that allow them to catch many mistakes.

But as long as you have backup for all your numbers, you shouldn't worry.

Still, here are five important things you should to know about the IRS audit process that will probably calm your fears.

For more tax tips, check out TheStreet's Tax Center

Editors' pick: Originally published April 14.

1. The number of audits are decreasing and so is the revenue collected
1. The number of audits are decreasing and so is the revenue collected

Last year, the IRS audited a total of almost 1.2 million tax returns. That's about 0.6% of all returns -- individual and corporate -- filed in the 2015 calendar year.

"That's actually lowest number of audits in more than a decade," said IRS Commissioner John Koskinen, at a recent speech he gave at the National Press Club in Washington, D.C.

And that means the Service is not collecting nearly enough money. "A 1% drop in the compliance rate translates into a loss of more than $30 billion in revenue a year," he said.

Think about what a loss of $300 billion over ten years would mean to the federal deficit.

Not good.

2. The IRS has staffing and computer issues
2. The IRS has staffing and computer issues

It's no secret that the IRS's staff has shrunk, thanks to budget cuts. 

According to Koskinen, the staff is 38% below where it was 60 years ago and over 50% below 20 years ago. And we all know the tax code has only gotten more complicated over that time.

But Congress has consistently cut the IRS's budget. (Targeting conservative 501(c)(4) non-profit groups back in 2014 didn't help.) And it doesn't look like President Trump is going to make things much better. His budget reduces funding for the IRS by $239 million.

And much of the money the agency receives is earmarked for customer service, says Mark Luscombe, principal analyst at Wolters Kluwer, a tax and accounting services company. But customer service doesn't help the collection effort.

In addition, Koskinen estimates that "60% of the IRS's hardware and 28% of our software are out of date and in need of an upgrade."

(It's like sending the Marines to war without guns.)

3. Beware of the Automated Underreporter
3. Beware of the Automated Underreporter

There are still simple ways for the IRS to catch your mistakes, intentional or not.

The IRS does have a system that matches your tax return to some third-party documents, like W-2s and 1099s, says Melanie Lauridsen, senior manager on the AICPA's Tax Policy and Advocacy Team. The system, called the Automated Underreporter, basically scans both to make sure they match. 

It will catch about 25 million mismatches, says Lauridsen. But then an IRS agent has to determine that a mismatch was made. If it's legit, a letter is sent out.

About 6.5 million letters were sent to taxpayers last year.

Big note: electronically filing your return greatly reduces your chance of getting one of these letters.

4. There are still things that are audit red flags to the IRS
4. There are still things that are audit red flags to the IRS

The IRS still has its list of red flags.

If you file a Schedule C - Profit and Loss from Business, there is a perception that you can list personal expenses as business expenses, says Luscombe. So document everything. 

People also report "hobby losses" on Schedule C, which are an IRS target. Hobby losses are for ventures that really aren't supposed to make money -- like raising horses or racing cars. (Rich people hobbies mostly.) But they try to report it as a business and the IRS sees right through it. 

While they don't have the manpower to make sure your home office is strictly used for business and doesn't double as your kids' play room, reporting a home office deduction does raise an eyebrow. 

So do big swings from one year to the next in things like charitable contributions, large losses, etc. 

So look at the norms compared to your peers. Wolters Kluwer compiled a list of average itemized deductions, so make sure you fall in it or can document why you don't.

5. Don't ignore correspondence
5. Don't ignore correspondence

Remember, Uncle Sam will never call, text or email you initially. Be super cautious of identity theft. But if you do get a letter, don't ignore it.

Just give the IRS the information its wants, says Lauridsen. Sometimes it could be as simple as reporting a number on the wrong line. And many times the IRS is wrong, so don't be afraid to defend yourself.

But as long as you document everything, you're better off spending more time worrying about getting to your kid's lacrosse game than an audit these days.

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