Why millionaires should worry about tax audits

Rebecca Lake
Tips to Avoid a Tax Audit from IRS
Tips to Avoid a Tax Audit from IRS

The words "tax audit" are enough to send a shiver down anyone's spine, but some taxpayers are more likely to be subjected to the scrutiny of the IRS than others. If you're pulling in a salary that's in the seven-figure range, you could be a bigger target than the average Joe or Jane. The IRS recently released audit figures from fiscal year 2015 and there are a few trends that may be worrisome to millionaires.

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Millionaires Are More Likely to Face Audits

milli audit 2 Why Millionaires Should Worry About Tax Audits
milli audit 2 Why Millionaires Should Worry About Tax Audits

In 2015, income tax returns with a reported income of $1 million or more had about a 9.55% chance of being pulled for an audit. Those odds are roughly 27.3% percent higher than they were in 2014. In contrast, taxpayers who earned less than $200,000 per year only had a 1% chance of getting audited by the IRS.

Correspondence Audits Are Becoming More Common

milli audit 3 Why Millionaires Should Worry About Tax Audits
milli audit 3 Why Millionaires Should Worry About Tax Audits

While more wealthy Americans are being audited, Uncle Sam is changing up its approach in terms of how the audits are carried out. Instead of conducting field audits, the IRS is increasing the number of correspondence audits. Since 2014, the number of field audits dropped by 8% while correspondence audits increased by a whopping 34%.

Correspondence audits don't require taxpayers to speak with IRS examiners face-to-face, but they don't necessarily streamline the audit process either. After a computer looks over your tax return and finds an error, you'll receive a letter that highlights the information that's being questioned. Then, it's your responsibility to provide supporting documentation to justify why you deducted certain expenses or claimed a particular filing status.

Related Article: What Is the Standard Deduction?

If the IRS isn't willing to accept your explanation based on the documents you provide, you might be able to talk to someone over the phone. Without having the opportunity to speak to someone from the IRS, however, you could end up with a big tax bill once the audit is complete.

Every single detail on a tax return won't necessarily trigger a correspondence audit. Instead, this type of audit tends to zero in on things like excessive deductions.

Related Article: How to File Taxes

How the Rich Can Avoid a Tax Audit

Statistically, wealthy taxpayers are prime targets for tax audits but if you're a millionaire, there are some things you can do to lower your chances of being audited. Here are a few tips to keep in mind as you prepare your tax return:

  • Choose a reputable accountant. If you're making millions of dollars a year, it's a good idea to find someone you can trust to handle your tax filing. Before choosing an accountant, it's best to review his or her track record to make sure the accountant is reliable, professional and above all, ethical.

  • Avoid major deviations from year to year. The IRS uses a computer algorithm to determine which returns should be selected for review. One thing the algorithm checks for is any variation in income. If you go from making $1 million to $5 million over the course of a year, that may be considered a red flag.

  • Track expenses carefully. Deductions reduce your taxable income and can be a big help when you're raking in the dough. But writing off too much can attract unwanted attention. When adding up deductible expenses, it's important to make sure that they're within the limits allowed by the IRS. Be prepared to back up your claims with receipts, profit and loss statements and other documents in case an auditor comes calling.

Related: The best ways to avoid tax audit

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The post Why Millionaires Should Worry About Tax Audits appeared first on SmartAsset Blog.

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