Tax time is upon us. This year, as my husband and I finished filing online, the software program asked if we wanted to purchase the company’s audit defense product for an additional $39.95. I agreed without thinking much about it, but I realized that I should probably have done a little research first.
Here’s what we are promised for that extra fee: The company will defend our return from audits for seven years. That includes scheduling and representing us at meetings with the IRS in the event of an audit, along with miscellaneous advice and assistance along the way.
Is it worth it to pay extra for audit protection? The short answer is: probably not, especially if you are filing a straightforward and basic return. To evaluate your risk of being audited so you — unlike me — can make an informed decision, consider the following factors.
(1) Audit rates are going up, but mostly for the rich.
In 2011, the most recent year for which statistics are available, IRS audits jumped 62 percent for the wealthiest taxpayers. Almost one in three taxpayers earning over $10 million, and one in five of those earning between $5 million and $10 million, got a call from the IRS in 2011.
However, overall just over 1 percent of all individual returns are audited each year. If you earn less than half a million dollars in household income, your chances are well below 3 percent of getting audited in a given year.
(2) Complicated returns increase your risk.
If you are self-employed, filing a schedule C, your risk of an audit is raised. This is especially true if you have a business with very high expenses that is really more like a hobby — for example, making collectible dolls to sell at flea markets. Home offices are a notorious audit red flag — this deduction was simplified for 2013, but when filing your 2012 taxes, you still need to fill out a complicated form showing that a portion of your home square footage is dedicated 100 percent to business. Other red flags, according to tax attorneys, are large itemized deductions such as those for business travel and entertainment, charitable deductions featuring lots of noncash donations (are your old shoes really worth $150?), and claims for medical expenses. All must be well documented with receipts.
(3) So do errors.
If you forget to enter any of the investment income reported on your Form 1099s, or if you have any other missing pieces, this can cause the IRS to reconsider your return. Even arithmetic mistakes might bring your tax return greater scrutiny. This is where tax preparation software can come in handy, if you are doing returns yourself, to make sure you don’t make any careless mistakes.
If any of these risk factors apply to you, or if you’re just risk-averse by nature, you may be tempted, as we were, to pay for audit protection. Unfortunately, some consumers complain that the audit protection services offered by tax preparers are really not worth the money.
If they can show that you made a mistake in the information you submitted, some audit protection services may use that as an excuse not to honor your claim. Also, many consumers say that using such services cost them additional delays, confusion and often money. Imagine haggling with an insurance company over a small claim while negotiating with a tax auditor. That sounds very different from “peace of mind.”
If your situation is complicated, it might be better to employ an accountant, certified planner or attorney. A certified professional can be found in your zip code at the National Association of Tax Professionals website: https://www2.natptax.com/eweb/DynamicPage.aspx?webcode =NATPDirZipSearch