Higher Income = Higher Chance of Audit?

IRS-SIGNHave you ever heard of the IRS Data Book?

 

While sorely lacking in pictures, the IRS Data Book is a fascinating read.

 

I’m serious.

 

Published annually, it’s a peak behind the curtain, and reveals all sorts of fun facts regarding number of returns filed, taxes collected, and agency enforcement. For example, the IRS received 146 million individual tax returns in fiscal 2012… and examined just over one percent of them.

 

In other words, 1.5 million unlucky individuals got audited.

 

That’s interesting in itself. But what’s even more interesting is that some groups get audited at a much higher rate than others. Want to know who the IRS is targeting? Take a look at this chart (source: Wall St. Journal).

 

Income                                              % of returns audited

 

general population                                      1%

 

$500,000 – $1 million                              3.57%

 

$1 million – $5 million                                8.9%

 

over $10 million                                         27.4%

 

So there it is, clear as day. If you’re wealthy, you have a target on your back. The higher your income, the higher your chances of being audited. And there seems to be a line drawn in the sand at $10 million, because auditing rates skyrocket when that threshold is reached.

 

What draws extra scrutiny from the IRS? According to a recent Wall Street Journal report, here are the activities that attract the attention of enforcement agents:

  • owning a closely held business
  • having partnerships
  • a portfolio of hedge funds or other complicated investments
  • unusual events such as the sale of a business
  • making a large charitable contribution
  • claiming large deductions

We have a team that works with successful business owners to both lower their taxes and lower their risk of audit. Reading the IRS Data Book numbers gives me a new appreciation for the team. Because after working with thousands of wealthy business owners across dozens of different industries, their audit rate is under 1% — even lower than the general population.

 

How have they managed such an enviable record? I believe there are 3 key factors:

 

1.) Having the right members on the team. Properly structuring protective tax strategies requires the efforts of both specially trained CPAs and tax attorneys working as a team – having a CPA alone is not enough. For example, the 1040 is the most scrutinized form. Moving income off your 1040 and into the proper entity structure can exponentially lower your audit risk. Creating entities is the purview of a tax attorney.

 

2.) Staying clear of red flags. Our team leader was the former tax manager at a Big Four accounting firm. His responsibility was to minimize and audit-proof the tax returns of the firm’s 177 wealthiest clients, including billionaires. There are few situations that he hasn’t seen and addressed. His implementation philosophy: avoid all “grey areas” and steer clear of the red flags that attract inquiries.

 

3.) Experience. Our lead tax attorney is an IRS “insider,” who for years served as his state’s liaison to the Internal Revenue Service in formulating tax policies. He was also Vice Chairman of the American Bar Association’s Tax Section of the General Practice Council, and Chair of the State Bar Association’s Federal Tax Committee. It can be reassuring to have this type of clout and experience on your side.

 

If you or a business owner you know wants to reduce the chances of an audit…and save on taxes, call or email us today for a free tax savings and audit reduction analysis by our leading tax attorneys.