Do I Qualify for an IRS Offer in Compromise?

If you’re facing outstanding tax debt that you cannot pay, you may want to consider looking into an Offer in Compromise from the IRS. Specifically, an Offer in Compromise is an option offered from the IRS to qualifying individuals that allows them to settle tax debt for less than what they actually owe.

Unfortunately, there seem to be a lot of misunderstandings about Offers in Compromise; many people falsely believe that these are seldom accepted by the IRS. In reality, it is estimated that the current acceptance rate is over 40%, with the average dollar amount of a settlement reaching more than $10,000.

If you’re worried about your inability to pay tax debt, knowing the basic qualifications of an IRS Offer in Compromise and what to expect from the application process can be extremely helpful moving forward.

How to Know if You Qualify

Generally, there are three factors that are considered by the IRS when somebody applies for an Offer in Compromise. Most commonly, the IRS must have a belief that you will not be able to pay your tax debt off at any point in the near future. This means that your financial situation is probably not going to improve anytime soon and that the IRS would not likely be successful in forcing collections on you.

At the end of the day, the IRS needs to believe they are getting a fair deal – so if you have any potential to pay your debt at any point in the near future, you may not qualify.

You might also qualify for an Offer in Compromise if there is doubt as to your actual tax liability; if you have documentation proving that you owe less in taxes than the IRS believes to be true, or if an assessor has made a mistake on your reporting, you may be more likely to have an Offer in Compromise accepted by the IRS.

Finally, if paying your tax bill would create a significant financial hardship, you may also qualify for an Offer in Compromise. Of course, proving financial hardship can sometimes be a challenge.

In addition to all of these considerations, there are several other eligibility requirements that you must meet in order to qualify for an Offer in Compromise:

  • You must pay the application fee
  • You must have filed all of your required tax returns
  • You cannot be going through a bankruptcy at the time of filing
  • You must submit all required documentation

What to Expect From the Process

One of the most complicated aspects of going through the application process for an IRS Offer in Compromise is filling out and submitting all the required paperwork. There are several documents you may need to complete to even be considered for an Offer in Compromise, including:

  • IRS Form 433-A – this form requires information on your assets, liabilities, expenses, and income to determine your Reasonable Collection Potential.
  • IRS Form 433-B – this form needs to be filled out for businesses applying for an Offer in Compromise.
  • IRS Form 656 – use this form to apply for an Offer in Compromise so long as there are no doubts as to your tax liability.
  • IRS Form 656-L – use this form to apply if you are disputing your tax liability to the IRS.

In addition to completing these official forms as part of the application process, you will also need to provide some documentation, such as:

  • health care statements
  • bank and credit card statements
  • investment information
  • proof of living expenses
  • car loan, mortgage, and similar loan statements
  • copies of related tax returns

Working With a Tax Professional Can Help

As you can probably see, the process of determining your eligibility and applying for an Offer in Compromise with the IRS can be quite time consuming and complex. This is where it can be helpful to consult with a tax professional for assistance. A qualified and experienced tax professional will be able to assess your current tax situation and give you a better idea as to whether or not going through the Offer in Compromise application process is worth your time and efforts.

If so, he or she will also be able to assist you with the application process, ensuring that you’re filling out the correct forms and that you submit all required documentation as well. This can increase your chances of reaching a successful offer with the IRS and take a lot of the stress and burden off your chest.

Even if you don’t qualify for an Offer in Compromise, your tax professional may be able to assist you in figuring out other alternatives for making your tax payment more financially manageable for you. This might include options to work out a payment/installment program with the IRS, among other options.

The Bottom Line

Overall, getting an Offer in Compromise accepted by the IRS is nearly a 50/50 shot – but if you meet the eligibility requirements and take the time to correctly submit all paperwork and documentation, your chances of reaching an offer are high. And the best way to get the help you need in gathering this documentation and submitting this paperwork is to consult with an experienced tax professional, so reach out to yours today. If you don’t already have a tax professional that you can turn to, schedule a consultation with one at your earliest convenience to get the ball rolling.

2019 Standard Mileage Rates Announced

Article Highlights:

  • Standard Mileage Rates for 2019
  • Business, Charitable, Medical and Moving Rates
  • Important Considerations for 2019
  • Switching between the Actual Expense and Standard Mileage Rate Methods
  • Employer Reimbursements
  • Employee Deductions Suspended
  • Special Allowances for SUVs

The Internal Revenue Service (IRS) computes standard mileage rates for business, medical and moving each year, based on a number of factors, to determine the standard mileage rates for the following year.

As it does annually around the end of the year, the IRS has announced the 2019 optional standard mileage rates. Thus, beginning on Jan. 1, 2019, the standard mileage rates for the use of a car (or a van, pickup or panel truck) are:

  • 58 cents per mile for business miles driven (including a 26-cent-per-mile allocation for depreciation). This is up from 54.5 cents in 2018;
  • 20 cents per mile driven for medical or moving* purposes. This is up from 18 cents in 2018; and
  • 14 cents per mile driven in service of charitable organizations.* For years 2018 through 2025, the deduction for moving is only allowed for members of the armed forces on active duty who move pursuant to a military order. 

The business standard mileage rate is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs determined by the same study. The rate for using an automobile while performing services for a charitable organization is statutorily set (it can only be changed by Congressional action) and has been 14 cents per mile for 20 years).

Important Consideration: The 2019 rates are based on 2018 fuel costs. Based on the potential for substantially higher gas prices in 2019, it may be appropriate to consider switching to the actual expense method for 2019 or at least to keep track of the actual expenses, including fuel costs, repairs and maintenance, so that the option is available for 2019.

Taxpayers always have the choice of calculating the actual costs of using their vehicle for business rather than using the standard mileage rates. In addition to the potential for higher fuel prices, the extension and expansion of the bonus depreciation as well as increased depreciation limitations for passenger autos in the Tax Cuts and Jobs Act may make using the actual expense method worthwhile during the first year when a vehicle is placed into business service.

However, the standard mileage rates cannot be used if you used the actual method (using Section 179, bonus depreciation and/or MACRS depreciation) in previous years. This rule is applied on a vehicle-by-vehicle basis. In addition, the business standard mileage rate cannot be used for any vehicle used for hire or for more than four vehicles simultaneously.

Employer Reimbursement – When employers reimburse employees for business-related car expenses using the standard mileage allowance method for each substantiated employment-connected business mile, the reimbursement is tax-free if the employee substantiates to the employer the time, place, mileage and purpose of the employment-connected business travel.

The Tax Cuts and Jobs Act eliminated employee business expenses as an itemized deduction, effective for 2018 through 2025. Therefore, employees may no longer take a deduction on their federal returns for unreimbursed employment-related use of their autos, light trucks or vans. Members of a reserve component of the U.S. Armed Forces, state and local government officials paid on a fee basis and certain performing artists continue to be allowed to deduct unreimbursed employee travel expenses, including the business standard mileage rate, because they are deductible from gross income rather than as an itemized deduction.

Faster Write-Offs for Heavy Sport Utility Vehicles (SUVs) – Many of today’s SUVs weigh more than 6,000 pounds and are therefore not subject to the limit rules on luxury auto depreciation. Taxpayers who purchase a heavy SUV and put it into business use in 2019 can utilize both the Section 179 expense deduction (up to a maximum of $25,500) and the bonus depreciation (if the Section 179 deduction is claimed, it must be applied before the bonus depreciation) to produce a sizable first-year tax deduction. However, the vehicle cannot exceed a gross unloaded vehicle weight of 14,000 pounds. Caution: Business autos are 5-year class life property. If the taxpayer subsequently disposes of the vehicle before the end of the 5-year period, as many do, a portion of the Section 179 expense deduction will be recaptured and must be added back to the taxpayer’s income (self-employment income for self-employed individuals). The future ramifications of deducting all or a significant portion of the vehicle’s cost using Section 179 should be considered.

If you have questions related to the best methods of deducting the business use of your vehicle or the documentation required, please give this office a call.

Most Common Types of IRS Tax Problems

Receiving notification from the Internal Revenue Service that there’s some kind of problem is one of the most bone-chilling situations an American taxpayer can experience. Just receiving an envelope with a return address from the IRS can strike fear. There are many different reasons that the IRS might reach out, but some are more common than others.

Here are the top issues that would cause a taxpayer to hear from the IRS or require you to resolve an issue:

  • An Error On Your Tax Return – Nobody’s perfect, and filling out tax returns is not an easy thing. If you’ve made a mistake, whether it’s something simple like filing status or number of dependents or something bigger like total income or incorrectly claiming a deduction, if you discover it on your own, all you need to do is file an amended return using form 1040X, the Amended Individual Income Tax Return. If the mistake means that you owe more money, quickly submitting the amount that you owe will help you avoid having to pay too much in penalties or interest. It’s not at all unusual for the IRS to discover mistakes – especially math mistakes – and they will generally notify you that they have made corrections on your behalf.
  • Mismatched/Underreported Income – Along the lines of the mistakes referenced above, there is a specific form that the IRS will send you if they determine that the amount of income you report on your tax return is different from what has been reported by employers. That form is the CP2000 Notice, and the agency will send it to you, notifying you of the corrected amount, should they review your return and feel that it is appropriate.
  • Failure to File a Tax Return – Filing a tax return isn’t necessarily required if you don’t owe money or if you’re owed a tax refund, but it’s not a good idea. Failing to file a return when you’re owed a refund puts you at risk of losing out on receiving the money you’ve owed – you have just three years to amend the problem if you want to get your money. For those who are in arrears to the IRS, there is a significant negative outcome to failing to file a return, including having to pay a “failure to fee” penalty that can go as high as 25 percent of your unpaid tax bill: 5 percent of the amount you owe, plus interest, will be charged for each month for up to five months
  • You Owe the IRS for Taxes Not Paid – When the IRS calculates that you have not paid them the full amount that you owe, they will send you notification of what they believe the difference is via form CP14.
  • You Owe the IRS Penalties and Fees – When you don’t pay your taxes or you fail to file a return, the IRS will notify you that you owe them penalties, and possibly interest.
  • You Owe the IRS But Can’t Afford to Pay – There are many taxpayers who find themselves facing a tax bill that they are simply unable to pay all at once. If you fall into this category, the IRS does offer the option of paying in installments. To request this type of payment plan, contact the agency. If even paying in small increments is outside of your ability, you may be able to negotiate a reduced tax bill through what is called an Offer in Compromise.
  • Tax Debt Resulting in Tax Levy – If you are unable or unwilling to satisfy your tax debt, the IRS may opt for a tax levy, which is the legal seizure of your property in lieu of payment. A tax levy can take the form of real property such as real estate, your vehicle or personal property, or your wages, the money in your bank accounts or your financial accounts. Notification that a levy is being issued against you comes via either notice LT11, CP504, CP90, or CP91.
  • Notification that A Tax Lien Has Been Filed – If you have failed to pay your tax debt, the IRS may take action to protect its own interests ahead of other creditors by filing a tax lien. This comes in the form of Letter 3172, which will be sent to both you and your other creditors to let them know of the government’s claim against your financial assets, personal property and real estate. By sending this letter out, the government ensures that it will benefit from the liquidation of any of your property in order to satisfy the amount that it is owed. Once a lien has been placed on your property, it is extremely difficult to get out of until you’ve paid up.

A notification from the IRS is not something to be ignored. The best step is to take a deep breath, read the notice carefully, and if needed, contact our office for assistance.

Reasonable Compensation and S Corporations

Article Highlights:

  • Payroll Taxes
  • Corporate Officers
  • Employees of a Corporation
  • Reasonable Salaries
  • Factors
  • Flow-Through Deductions
  • Wage Limitations

Unlike a C corporation, which itself pays the tax on its taxable income, an S corporation does not directly pay taxes on its income; instead, its income, losses, deductions, and credits are distributed across its shareholders’ individual tax returns on a pro rata basis. These distributions are not subject to self-employment (Social Security and Medicare) taxes. As a result, many S corporations ignore the requirement that each shareholder-employee must take reasonable compensation in the form of W-2 wages in exchange for services performed for the corporation. These wages are subject to Social Security and Medicare taxes (which the corporation and the employee generally split equally); the corporation is also responsible for paying the Federal Unemployment Tax (as well as any state unemployment taxes).

The Internal Revenue Code establishes that an officer of an S corporation is an employee of that corporation for Federal Unemployment Tax purposes. S corporations should not attempt to avoid paying this tax by treating their officers’ compensation as distributions rather than as wages.

This has been an issue for decades; in 1974, the IRS issued a ruling stating that, when a shareholder-employee fails to take a salary, or if that salary is unreasonable, an auditor should assert that the salary is unreasonable. The officer’s distributions will then be shifted to account for reasonable compensation, and he or she will be assessed the related employment taxes and penalties. At stake here are the employee’s 6.2% Social Security and 1.45% Medicare payroll taxes, the S corporation’s matching amounts, the Federal Unemployment Tax, and whatever state taxes happen to apply.

Who Is an Employee of the Corporation? – Generally, an officer of a corporation is considered an employee of that corporation. The fact that an officer is also a shareholder does not change the requirement that any payments made to that officer must be treated as wages. Courts have consistently held that S corporation shareholders who provide more than minor services to their corporation (and receive payment in return) are employees whose compensation is subject to federal taxes.

Tax regulations do provide an exception for officers who do not perform services or who perform only minor services. These officers are not considered employees.

What’s a Reasonable Salary? – The instructions for Form 1120S (“U.S. Income Tax Return for an S Corporation”) state: “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.” There are no specific guidelines in the tax code regarding the definition of reasonable compensation. The various courts that have ruled on this issue have based their determinations on the facts and circumstances of the individual cases. These are some factors that courts have considered when determining reasonable compensation:

  • The officer’s training and experience
  • The officer’s duties and responsibilities
  • The time and effort that the officer devotes to the business
  • The corporation’s dividend history
  • The corporation’s payments to non-shareholder employees
  • The timing and manner of the bonuses paid to key people at the corporation
  • The payments that comparable businesses have made for similar services
  • The corporation’s compensation agreements
  • The formulas that similar corporations have used to determine compensation

The problem here, of course, is that it is easy for the IRS to simply list contributing factors that courts have used when determining reasonable compensation and leave it to each corporation to quantify these factors and determine a reasonable salary—all while retaining the ability to challenge the selected amount later if an auditor decides that the compensation is not reasonable. The IRS has a long history of examining S corporations’ tax returns to ensure that reasonable compensation is being paid, particularly when a corporation pays no compensation to employee-stockholders.

New Issue For 2018 – The late-2017 tax reform added a new flow-through deduction (also referred to as the “199A deduction” after the section of the tax code that describes it). This deduction applies to S corporations (among many other business entities) and adds another level of complexity to the determination of reasonable compensation.

  • The wages of an S corporation’s employee-stockholder are NOT treated as qualified business income (QBI) that is eligible for the individual’s 199A deduction. However, the corporation deducts these wages as a business expense when it calculates the profit that passes through to the shareholder as QBI on Schedule K-1. Thus, larger wages mean less K-1 flow-through income (QBI) and thus a smaller 199A deduction (as that is equal to 20% of QBI). In this case, S corporations tend to minimize stockholders’ salaries in order to maximize flow-through income; this strategy increases the employee-stockholder’s 199A deduction and lowers the payroll taxes for both the corporation and the employee-stockholder.
  • If married taxpayers who are filing a joint return have 1040 taxable income that exceeds $315,000 (or $157,500 for those with other filing statuses), the 199A deduction begins to be subject to a wage limitation. Once the 1040 taxable income for married taxpayers filing jointly exceeds $415,000 (or $207,500 for those with other filing statuses), the wage limitation is fully phased in. In that event, the 199A deduction becomes the lesser of the wage limitation or 20% of the QBI; if the wage limitation is zero, there is no 199A deduction.The wage limitation comprises the wages that the corporation paid, including those paid to stockholders, plus the unadjusted cost of the qualified property that the corporation owned and used during the year. To be more specific, the wage limitation is the larger of
  • 50% of the wages that the corporation paid or
  • 25% of the corporation’s paid wages plus 2.5% of the unadjusted cost of its qualified property.

Thus, for those high-income shareholders for whom the wage limitation applies, if the corporation pays no wages and has no qualified property, the shareholder will not have a 199A deduction.

If an S corporation is a specified service trade or business, the 199A deduction phases out; for married taxpayers who are filing a joint return, it phases out at taxable incomes between $315,000 and $415,000 (for those with other filing statuses, it phases out between $157,500 and $207,500). The IRS describes specified service trades or businesses are those in the fields of health, law, accounting, actuarial science, performing arts, athletics, consulting, financial services, and brokerage services, as well as those for which reputation and/or skill are contributing factors (for more details on what constitutes an specified service trade or business, please give this office a call).

Thus, if married taxpayers who are filing jointly have taxable income in excess of $415,000 (or $207,500 for those with other filing statuses), they receive no benefit from the wage limitation; therefore, they also tend to minimize their reasonable compensation in order to minimize their FICA taxes.

Of course, taxpayers cannot pick and choose a particular level of reasonable compensation to minimize their taxes or maximize their deductions; therein lies a trap. Taxpayers instead should consider all the factors related to reasonable compensation. However, pulling all the data together to support such a determination can be difficult and time-consuming. Some commercial firms have the necessary data and resources to properly apply the various factors mentioned in this article so as to determine the proper level of reasonable compensation; this can provide backup in the case of an IRS challenge.

Please give this office a call if you have questions related to reasonable compensation for S corporation shareholders or how it impacts your specific tax situation.

5 Reasons to Amend a Previously Filed Tax Return

The most recent data from the IRS on individual tax returns indicates that of 131 million returns filed, about 5 million were expected to be amended. This comes to less than 4 percent, but that projection still affects a significant number of taxpayers. Filing an amended tax return can be a hassle that you definitely want to avoid if possible. But there are some situations where you’ll have to do so, and it’s prudent to seek out the help of a tax advisor who can guide you through the process. Here’s why you may need to file an amended tax return.

1. You made a math or data entry mistake and didn’t realize it until after you submitted your tax return.

For example, you added up your charitable deductions, and after filing your return, you realize you added them up incorrectly, and the difference was sizeable. Filing an amended return can correct that math error and get a refund.

Perhaps you were entering your gross income from your self-employed business into your software while it was late and you were tired, and you inadvertently transposed the numbers and entered the gross income as $78,000 when it was really $87,000. You will need an amended return to correct that error.

However, you would not usually amend a return if you incorrectly entered W-2 income since the IRS receives a copy of the W-2 and will compare it with what you reported and if there was an error, they will automatically make a correction and send you a bill or a refund as the case might be. The IRS website instructs taxpayers not to amend a return in such a situation.

The statute of limitations for refunds is three years for the due date the tax return and if the IRS has not automatically made the correction and you have a refund coming don’t let the statute of limitations expire before filing an amended return. That holds true for any situation were an amended return will result in a refund.

2. You used an incorrect filing status.

Single parents, caregivers of elderly parents, and recently married or divorced people often make the mistake of using “Single” status when it’s the wrong one. “Heads of Household” miss out on crucial tax benefits, while married people will generally need to use “Married Filing Separately” if they don’t wish to file a joint return with their spouse. Because filing status affects so many elements of your tax return, you need to file an amended return to pay additional taxes you owe or receive a refund once the correct one is used.

3. You didn’t realize that there was a tax benefit you qualified for, and you’d like to claim it now.

There are many frequently overlooked tax benefits a tax professional would be aware of that the average DIY person wouldn’t, such as the ability for most individuals and small business owners to make pension and profit-sharing contributions in a new year before the tax-filing deadline and still have it count for the current filing season.

This also works in reverse in that people accidentally claim benefits they weren’t actually entitled to. Often, the best way to know for sure is to consult a tax professional.

4. You had investing activities that affect your tax return.

Typically, you don’t realize a capital gain or loss until you actually sell an asset. But if securities become worthless, this results in a capital loss that needs to be reported the year it was deemed worthless, and not the year you discovered the fact. If this security was deemed worthless a long time ago, you may have to amend prior year returns to account for the capital loss.

This can be significant since you are limited to deducting $3,000 in capital losses from all of your other income and result in capital loss carryovers that last several years. If you have any other investment losses that were forgotten or miscalculated on your original tax return, filing an amended return is the next logical stop to ensure your carryovers are done correctly for future tax returns.

5. You received tax forms after filing your tax return.

If you were due a W-2 or 1099 form, you might not receive it when you’re initially preparing your taxes. It could be a surprise corrected form or the payer was just late sending it to you. But if you already filed your tax return, then got additional forms later on, amending your tax return becomes inevitable.

Amending your tax return can be a cumbersome process, especially if you’re self-employed and/or have a great deal of investing activity. Asking a tax professional to assist you with filing amended returns can eliminate the headaches that come with the process. Many even offer a free review of self-prepared returns and ask the right questions to determine if it’s worth it to amend this year’s return and any prior years’. You may also have to amend your state tax return(s), which can grow more complex if your residency is or was multistate.

Offer in Compromise FAQs

We’re all responsible for paying our fair share of taxes each year. But what happens when the amount that you owe is simply out of reach? What happens if you failed to make payments in a timely manner and your financial circumstances have shifted to the point where your cumulative debt is beyond your ability to pay? In the face of this untenable position, your best option for paying the IRS may be what is known as an Offer in Compromise.

The Goal of the Offer in Compromise

The Offer in Compromise, or OIC, was created to accomplish two goals: it allows American taxpayers who are unable to pay the full amount of their tax debt a way to negotiate a payment that is in keeping with their ability to pay, while at the same time providing the IRS with the ability to collect at least a portion of the amount that is owed to them. The process is neither simple nor fast: it generally takes at least one to two years for both sides to come to an agreement on an amount to be paid.

Even so, it has certain advantages for both sides.

An Offer in Compromise generally allows for resolution to be accomplished outside of court, with the agreed-to payment reflective of income and assets rather than the actual amount of debt that has accrued. Though it may seem a loss for the IRS, the agency ends up recovering more as a result of settling than they are likely to through a strong-arm collection process.

Understanding the Available Offer in Compromise Options

Taxpayers interested in pursuing an Offer in Compromise generally have three different options available to them under federal law. They are to suggest that they do not actually owe the tax debt that they are being charged with; to indicate that there simply are not enough assets or income to make a payment on the debt that has accrued; or to pursue a compromise based on either exceptional circumstances or economic hardship. This last option falls under the category of “effective tax administration,” and is notable because the taxpayer makes no argument as to either their ability to pay or whether they, in fact, owe the named amount.

Applying for an Offer in Compromise

The OIC process is both time-consuming and complicated. Applications require specific forms as well as extensive documentation, and all must be accurately prepared in keeping with IRS regulations. When mistakes are made or forms are incomplete the applications are quickly returned without the benefit of a review. To minimize both delay and frustration, it is strongly suggested that taxpayers looking to avail themselves of an OIC employ tax professionals for both the preparation of their paperwork and the negotiation of its terms.

Not Every OIC Application is Approved

It is also important to remember that an application for an OIC by no means guarantees the desired outcome. Submitting the specifics of your situation to a qualified tax professional will provide you with the ability to have your case reviewed by an expert who understands the process and the IRS criteria for approval, and who will be able to give you a reasoned perspective on the viability of your request.

Working with a professional will also provide you with reasonable expectations regarding the amount of time that the process will take and what your chances are of having your initial offer accepted. The program generally takes about two years from start to finish, and it is common for the IRS to make a counteroffer when the agency believes it will be able to collect more than the amount proffered by the applicant.

In evaluating your case, the Internal Revenue Service will likely pay less attention to the actual amount that is owed than the amount that the taxpayer is able to pay. This determination will be made on the basis of numerous factors, including income, assets, previous earnings capacity and anticipation of your earnings capacity in the future. Living expenses will also be taken into consideration.

The good news is that from the time that an application is sent in and while an IRS evaluation is taking place, most collection efforts are frozen. This generally provides tremendous relief from stress for taxpayers who have fallen behind in their payments and who feel unable to submit the amount that they owe.

If you have found yourself in this situation, contact us today to discuss your options. An experienced and knowledgeable tax expert will help you to understand, anticipate, and prepare for all aspects of the Offer in Compromise process, and will act as your advocate during sensitive negotiations.

Why Am I Being Audited by the IRS?

With the 2018 filing season currently behind us, notices have started to appear in mailboxes. While the IRS letterhead strikes fear into the hearts of most Americans, a vast majority of those notices are nothing to fear, since most of them are computer-generated and referring to outstanding tax bills you haven’t paid yet or errors on your tax return that can be easily addressed. Simply getting an IRS notice is not indicative of an audit.

With the numbers in for 2016 tax returns per the release of the IRS’s 2017 data book, fewer than 1 percent of individual tax returns were selected for a field or correspondence audit, which gives most people a 1-in-160 chance. But the Taxpayer Advocate Service watchdog group says that it’s actually 6.2 percent of tax returns, or a 1-in-16 chance of being audited. While audits demand back-up material and examining your past tax returns opposed to simply fixing errors or paying your unpaid tax bills, some of those computer-generated notices are more pernicious in their documentation requests and count in that 6.2 percent. “Audit flags” that don’t merit a full tax return audit but a partial one also count.

An incredibly minute amount of the hundreds of millions of individual tax returns that get filed every year will be audited. But if you want to know why you’re under audit or what the risk factors are that increase the likelihood of being audited, here’s what you need to know about the IRS audit process.

1. You were incredibly unlucky and got randomly selected.

In 2017, only 934,000 tax returns were audited, with 71 percent of them being done by mail, opposed to field audits (those intimidating series of face-to-face meetings you see in movies). Of this number, a microscopic portion were randomly selected.

The IRS always audits an incredibly tiny sample of tax returns, but the likelihood is still extremely low given that the incidence of random selection was reduced under the sequestration in 2013 and remained low even after the IRS petitioned for more funding. But if you are low or middle income with a relatively simple tax filing situation and wondering why you’ve been audited, you were part of that tiny random selection.

2. Your tax return has a common audit flag.

Even if you have legitimate deductions, credits and income substantiation, there are certain lines on your tax return that are rife with errors and fraud across the board. These include the charitable contribution deduction, home office deduction and adoption tax credit.

Specific tax benefits prone to error and fraud like the Earned Income Tax Credit have their own separate due diligence process. But the above three items are the most common triggers for an audit, even just partial audits, given the vast propensity people have in underestimating these items and not having them properly documented. People tend to overestimate the value of non-cash charitable contributions and frequently lack the substantiation for these deductions. Adoption is an incredibly long and expensive process, and even though it is a legitimate tax benefit in which the adoptive parents will have substantiation, it also equates to a tax credit that can spread out over numerous years and result in paying little or no tax. Because of this, the IRS flags these tax returns frequently.

The home office deduction is another area where people tend to overestimate both eligible expenses and the percentage or square footage of the home being used for the deduction. This deduction can also generate a business loss, resulting in paying little or no taxes. Because of this, the IRS is likely to flag tax returns that have suspiciously large home office deductions.

3. Someone tipped off the IRS that you could be cheating on your taxes.

The IRS has a whistleblower program that awards up to 30 percent of the taxes collected and resultant penalties. If your ex-spouse suspects that you fudged your Goodwill donations or that co-worker who doesn’t like you overheard you say, “They never check!” with respect to that side hustle you didn’t report, it’s possible they could’ve anonymously tipped you off to get a quick payday.

4. If you’re a small business owner or freelancer and someone with whom you do business was audited, you have an increased likelihood of being audited.

Even if your client, supplier or other business associate was not committing tax fraud or malfeasance but simply got audited, people and companies that they paid or received money from are likely to be next. If they didn’t correctly report payments made, the IRS will want to see how the payers’ or recipients’ tax returns also match up.

While random selection has a low probability, most audit flags are beyond your control. Always have proper substantiation in case you get that information request.

Our tax relief experts are available to be your dedicated resource to take the stress out of resolving your IRS notice in the shortest amount of time possible.