The “Audit Flag” Myth

It seems that most accountants try to sway their clients based on their fear of IRS audit.  We have seen some practitioners go to great extremes to keep their clients captive in this fear that “if they leave that accountant they will be audited”.  As you probably already know, I am a geek with regards to this stuff.  I have spent my career looking for a list of these mythical “audit flags” (an accountants unicorn, if you will).  Rest assured there is not a concise list of items that trigger an audit. 

The IRS runs data queries against taxpayer data to determine which taxpayers will create the largest yield from an audit.  Who they target varies from year to year based on current policy and existing law.  Unfortunately, these criteria are generally determined roughly two years after the return is filed.  Consequently, at the time we file the return we only have anecdotal information with regards to which returns we filed two years ago will be targeted.  Obviously, we mold our current returns based on this information, but do not have a list of “audit flags”.

Based on recently published information for the fiscal year 2011 – this means the 2009 tax returns – the IRS audited:

  • one in eight individuals with incomes over $1 million.
  • The overall audit rate for individuals remained steady at just over 1%
  • Congress appropriated $305 million less for the IRS in FY 2012 compared to FY 2011. This will potentially result in a reduced number of audits.
  • The IRS selected 1,564,690 individual returns for examination in FY 2011 compared to 1,581,394 individual returns selected for examination in FY 2010. Although there was a slight decline in the number of individual returns selected for audit in FY 2011, the overall audit coverage rate remained at 1.11 percent for FY 2011. The vast majority of individual audits were correspondence audits (1,173,069 in FY 2011 or roughly 75%).
  • The audit coverage rate for individuals with incomes under $200,000 was 1.04 percent in FY 2010 and fell to 1.02 percent in FY 2011. However, the audit coverage rate for individuals with incomes $200,000 and higher increased from 3.10 percent in FY 2010 to 3.93 percent in FY 2011.
  • Significant gains in audit coverage came in audits of individuals with incomes $1 million or more. The audit coverage rate for those millionaires increased from 8.36 percent in FY 2010 to 12.48 percent in FY 2011.
  • Field audits of individuals with incomes $200,000 and higher increased from 58,521 in FY 2010 to 78,392 in FY 2011. Field audits of individuals with incomes $1 million and higher increased from 16,509 in FY 2010 to 20,475 in FY 2011.
  • Examinations of business returns in FY 2011 decreased compared to FY 2010. Overall, the IRS examined 9,869,358 business returns (all types of businesses) in FY 2011. That number was 9,941,289 in FY 2010.
  • Corporations with assets $10 million and higher had the highest audit coverage rate at 17.64 percent in FY 2011 (16.58 percent in FY 2010).
  • Within the large corporation category, the audit coverage rate was highest for corporations with assets $250 million or higher at 27.6 percent for FY 2011.
  • The audit coverage rate for small corporations (corporations with assets under $10 million) was 1.02 percent in FY 2011 compared to 0.94 percent in FY 2010.
  • The audit coverage rate for partnerships in FY 2011 was 0.40 percent, compared to 0.36 percent in FY 2010.
  • The audit coverage rate also increased for S corps (0.42 percent in FY 2011 compared to 0.37 percent in FY 2010).
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