It’s a taxpayer’s worst nightmare: the letter in the mail from the Internal Revenue Service.
“It creates a lot of anxiety,’’ said Bob Meighan, a vice president at TurboTax.
Sometimes the notice is benign: You forgot to sign your return, or the IRS found you made a math error and are due a refund. But the more ominous ones question income or deductions.
In 2011, the IRS audited nearly 1.6 million individual returns, slightly more than 1 percent of the total. About three-quarters were done by correspondence, the rest in person by an IRS agent.
Only 1 percent of people with incomes under $200,000 had their returns audited; the audit rate for those with incomes of $1 million and higher was about 12.5 percent.
So how does the IRS select returns to audit?
“There’s no magic equation,’’ said Mark Steber, chief tax officer for Jackson Hewitt Tax Services.
Some returns are selected through computer screening. An IRS computer “basically compares data from your return to average numbers from people in similar situations and they look for variances,’’ said Jeff Schnepper, author of “How to Pay Zero Taxes’’ (McGraw-Hill, 2011). “They look for big changes, things that shouldn’t be there.’’
Reviewed are things like charitable contributions, interest income, and whether there are variations from averages in your income bracket or ZIP code. “Every time there’s a major variance, the computer is going to click,’’ he said.
Others are selected randomly, and still others by document matching to see if forms like the W-2 match what was reported on your tax return.
There’s yet another category - “related examinations,’’ the IRS calls it. “Returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit. “
The agency will notify taxpayers of an impending audit by telephone or mail. E-mail is not used.
The IRS Declaration of Taxpayer Rights sets forth what you can expect from an audit, ranging from confidentiality to professional and courteous service. Taxpayers have the right to have someone represent them and to make an audio recording of the session. They may appeal the judgment.
Accuracy is the best defense in an audit - and having the records to confirm it. Using tax-preparation software and filing electronically can help catch some common mistakes.
Claiming deductions for a home office probably will attract scrutiny, Steber said. As for charitable contributions, no particular amount is likely to catch the IRS’s attention.
Schnepper said the IRS sometimes focuses on taxpayers with cash earnings, like waiters, looking for unreported income.
It’s important to keep records for at least three years. “The name of the game with the IRS is paper,’’ Schnepper said. “Keep your records. Keep your receipts. If you have your receipts, you win.’’