What is an Unreal Tax Audit and How it Affects You

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What is an Unreal Tax Audit and How it Affects You

Have you heard of an “unreal tax audit”?  This term was coined by Nina Olson, the National Taxpayer Advocate who is the primary person given the watchdog responsibility by the government over the IRS.  “Unreal audits” are usually letters informing you of errors or omissions in your tax returns.  These audits may sound harmless and non-intrusive compared to full-scale audits, they can still cost you money.

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You might have heard that only about 1% of taxpayers receive audit notices from the IRS.  When considering the middle income group of taxpayers (who earn between $25,000 and $75,000 per annum), this ratio drops to less than 1%.  But in 2010, when you include the more than 9.2 million taxpayers who were received “unreal audit” notices, the percentage increases to a significant 7.4%.

At the same time, while normal audits are mostly targeted at the wealthy (12% of those earning more than $1 million a year were audited last year), the “unreal audits” seem to be focused on the lower and middle income groups.

An unreal audit can come in three forms, namely an Automated Under-reporter (AUR), a Math Error Notice and an Automated Substitute for Returns.  An AUR is where the income on your tax return does not match that of a related third party like your bank or employer.  A Math Error notice informs you that the IRS has rectified calculation errors in your tax return.  And Automated Substitutes for Returns are the tax returns the IRS files for you out of information from third parties.  This happens when you do not submit a tax return of your own.

In responding to these “unreal audits”, you should not ignore them nor panic assuming the IRS got everything right.  For example, your bank might have committed an error in giving the IRS incorrect information on your account or a Substitute return might not include all the deductions you are entitled to receive, both of which would trigger an “unreal audit”.  At the same time, most “unreal audits” come with a bill for unpaid taxes, so ignoring these audits is a foolish thing to do.

So the correct thing to do if you receive an “unreal audit” is to respond to it with proper documentation that corrects any errors in the audit.  Be prepared for a possibly long process and spending lots of time on the phone.

On another note, to avoid an “unreal audit” as far as it depends on you, you should check for accuracies from all third parties and if you discover any, try to correct them before you file your own taxes.  If it is not possible to do so on time, report the amount on your tax return and make an adjustment to correct the error.

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