“IRS is struggling on the enforcement front. 2013’s individual audit rate fell to 0.96%… one out of every 104 filed returns. It’s the first time in seven years that this key statistic dipped below 1%. And we expect this figure to sink even lower for 2014 as the agency’s resources continue to shrink. The number of enforcement personnel has decreased to its lowest level in years, partly due to budget cuts and reassigning agents to work identity theft cases.”
The Tax Letter breaks down to .88% for below $200,000 of income, 2.7% for above that level but below $1 million, and 10.85% for over $1 million of income (down from 12.14%)
The Tax Letter indicates certain red flags (some text omitted)
“Claiming 100% business use of a vehicle. They know that it’s extremely rare for an individual to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.
“Deducting business meals, travel and entertainment on Schedule C.
Big deductions here are always ripe for audit. A large write-off will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don’t satisfy the strict substantiation requirements.
“Writing off a hobby loss. Chances of losing the audit lottery increase if you have wage income and file a Schedule C with large losses. And if the activity sounds like a hobby…dog breeding, car racing and such…IRS’ antennas go up higher.
“Failing to report a foreign bank account. The agency is intensely interested in people with offshore accounts, especially those in tax havens, and tax authorities have had success in getting foreign banks to disclose account owner information. This is a top IRS priority. Keeping mum about the accounts can lead to harsh fines.
“Taking higher-than-average deductions. IRS may pull a return for review if the deductions shown are disproportionately large compared with reported income. But folks who have proper documentation shouldn’t be afraid to claim the write-offs.”
The last phrase is the key: if you have a proper reporting position with full documentation, then the risk of any adverse determination is drastically reduced (but you have the time lost responding if the IRS does raise a question).
Let me know if this raises questions for you.