President Biden has proposed boosting the IRS budget by $80 billion over 10 years, with the goal of increasing collections and cracking down on tax avoidance. The money will be used to expand the IRS’s resources, including hiring new agents and expanding and improving the IRS’s existing technology. Ultimately, the Biden administration hopes this new investment will help to raise around $700 billion over the next decade.[1]
The proposed increase in the IRS’s budget has yet to receive congressional approval, so the end result is unclear. But it is safe to assume that the IRS will gain some additional support. What will the resulting increase in enforcement mean to you?
Should you be concerned?
The vast majority of people won’t be affected by the ramping up of IRS enforcement activities. In fact, for most taxpayers, the chance of being audited is less than one percent.[2] And even with a sizable boost in the IRS’s budget, this figure is unlikely to increase significantly.
Nonetheless, you may be curious about the IRS’s process for selecting which returns to audit. Essentially, all tax returns are compared with statistical norms, and those that deviate significantly from these standards will undergo review by IRS personnel to determine if any action is necessary.
Although the IRS doesn’t publicize the criteria it uses to select returns for audit, several factors are thought to be correlated with a higher chance of being audited. These include:
- High levels of income. The odds of getting audited generally increase as your income goes up, especially if you have business income.
- Unreported income. Any institution that provides you with income— including employers, banks, and investment firms— will report it to the IRS.
- Business expenses. The IRS is often strict about mixing business and personal expenses.
Other potential red flags include taking larger-than-average deductions, including unusually high charitable contributions, and writing off losses for activities that are labeled a business activity but are more properly categorized as hobbies that don’t generate profits.
Be alert for scams targeting taxpayers.
If you receive a communication from the IRS, the first step is to make sure it really is the IRS. Scam artists claiming to be from the IRS have been targeting taxpayers for decades, and it is possible that this activity could increase along with the IRS’s expanded enforcement efforts.
The IRS will never make an initial contact by phone, email, or text—they will only contact you via letter. If you are contacted through any method other than a letter in the mail, don’t respond until you have discussed the matter with an advisor.
What to do if the IRS contacts you.
If you receive a legitimate letter from the IRS, don’t panic. A single communication doesn’t mean that you’re headed for trouble. Your first letter from the IRS—a “notice”—will likely just ask for additional information or clarification of something you included or omitted on your tax return. Areas of inquiry could include unreported income, filing status, number of dependents, and itemized deductions.
In many cases, a simple explanation will suffice to end the IRS’s inquiry. If you can explain why something was omitted or how you arrived at a figure different from the one used by the IRS, you may be able to settle the matter quickly by filing an amended return. If your error resulted in an underpayment, you will have to submit payment to make up for the error, but you’ll likely avoid penalties.
Keep in mind, however, that an error on your federal taxes may also affect your state taxes, as these are based on the adjusted gross income you reported on your federal return. Consequently, following a notice from the IRS, you might get one from your primary state of residence, which you will need to address as well.
The IRS audit process.
If the IRS proceeds past a notice to an actual audit, they are essentially asking you to substantiate what you have reported. Getting through an audit will take more effort than responding to a simple notice. You may have to come up with receipts, invoices, or other forms of documentation to prove your claim. And you may have to do some digging, because audits are often done on tax returns filed two or three years ago.
If you haven’t done so already, you will definitely want to contact your tax advisor at this point. If you work with Leelyn Smith, we will help you prepare your documentation and handle all correspondence with the IRS. We have a lot of experience guiding clients through the IRS review and audit process.
Make sure the IRS can reach you if needed.
One final point: If you have moved recently or spent extended time away from your primary residence, be sure to have your mail forwarded. For some communications, such as inquiries on underreported income, the IRS sets a 30-day deadline. You can request more time, but you need to respond—which means you need to receive the notice in the first place.
Leelyn Smith is here for you.
The Biden administration’s proposal to strengthen the IRS’s enforcement capabilities is significant. But the change, even if enacted, quite possibly won’t affect you. If you do receive a notice from the IRS, you can count on Leelyn Smith to be by your side every step of the way.
[1] CNBC, “Biden’s $80 billion plan to beef up IRS audits may target wealthy small business owners,” May 5, 2021
[2] Nolo Legal Encyclopedia, “What are the chances of being audited?”