How Likely is an IRS Tax Audit?
At this time of the year, Americans are focused on taxes. So, it is appropriate to consider what the inherent risk is of IRS audit. Each tax return filed has a unique profile, taking into account the amount and types of income reported, deductions and credits claimed. Nonetheless, published statistics do provide insight. The Internal Revenue Service issues an annual Data Book (Publication 55B); the 2016 edition has just been released, covering statistical data for the fiscal year (FY) October 1, 2015 to September 30, 2016 (FY2016). Here are some highlights.
- During FY2016, the IRS examined 0.6% of all returns filed in calendar year (CY) 2015, about 0.7% of all individual tax returns filed in CY2015, 1.1% of corporation income tax returns (excluding S corporation returns), 0.4% of partnership returns and 0.3% of S corporation returns. Examinations typically are handled through correspondence (examinations by mail) or in the field (face-to-face audits). The vast majority of FY2016 audits – 70.7% – were conducted via correspondence. The remaining 29.3% were conducted in the field.
- Of the 1,034,955 individual income tax returns examined in FY2016, over 36.7% were selected for examination on the basis of an earned income tax credit (EITC) claimed.
- One of the ways individual returns and examinations were analyzed by the IRS was by the amount of adjusted gross income (AGI). For returns with no adjusted gross income or less than zero (as a result of losses or statutory adjustments that exceeded total income), the examination coverage was 3.25%. Apart from the zero AGI level, the coverage rate increased as AGI increased – 1.01% or less for AGI levels under $500,000 to 18.79% for AGI of $10 million and above.
- The data also divided individual returns as business returns (with nonfarm sole proprietorships and/or farming) or nonbusiness returns. Nonbusiness returns without EITC and without Schedule E (supplemental income or loss) or Form 2106 (employee business expenses) showing “total positive income” under $200,000 were audited only 0.2% of the time; even with Schedule E or Form 2106, that percentage rose to just 0.7%. In general, “total positive income” is defined as the sum of all positive amounts shown for the various sources of income reported and thus excludes losses. Only 1.0% of individual nonbusiness returns with total positive income of at least $200,000 and under $1,000,000 were audited, compared with 2.3% for individual business returns without EITC for the same total positive income range. As might be expected, a higher percentage, 5.8%, of all individual returns – business and nonbusiness – with total positive income of $1,000,000 or more was audited.
- For corporate taxpayers, size does matter. For small corporations (no balance sheet returns to assets under $10 million), the examination rate was just 0.8%. For corporations with assets of $10 million or above, the rate was 9.5%. But that 9.5% is a bit misleading. For corporations with returns showing total assets of $10 million to under $50 million, the rate was 4.7% and for $50 million to under $100 million, the rate was 10.3%, with the rate rising to 78% for corporations showing total assets of $20 billion and above.
- Of the almost 1.2 million examinations of all tax returns, more than 29,000 taxpayers (approximately 2.5%) did not agree with the examiner’s determination.
- The percentage of returns examined through field audits with “no change” for individuals, corporations (other than S corporations), partnerships and S corporations was 8%, 30%, 46% and 31%, respectively.
On a percentage basis, the overall risk of audit is low. Indeed, the total number of returns (all categories) examined has gone down from over 1.7 million in FY2011 to under 1.2 million in FY2016, while the total number of returns filed has increased from almost 185 million in CY2010 to almost 193 million in CY2015. As would be expected, the percentage of returns audited generally increases as income levels rise. Greater levels of income often come with more and larger deductions and credits, which can add complication to the return and thus raise the profile for audit. One issue that seems to attract a particularly large amount of attention – and skews some of the numbers – is the earned income tax credit. The numbers explain why – recommended additional tax for individual returns audited in FY2016 with the EITC claimed totaled over $2.5 billion. Meanwhile, as noted above, the audit exposure for partnerships and S corporations was low, 0.4% and 0.3% respectively, but even at that low level, the Data Book 2016 indicated that 46% of partnership and 31% of S corporation field audits resulted in “no change.”