But what are you getting (and not getting) when you pay for audit defense? In what case does it make sense? And how can you do your best to avoid IRS audits altogether?
Keep reading to find out.
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What Do You Get With Audit Defense From a Tax Software Company?
I must credit a Clark listener for inspiring this story.
They asked: "Every year when I do my taxes with TurboTax they ask me if I want Audit Defense for about $50. Do they actively assist people who are audited, or is it just money wasted? I hope you provide your thoughts, because everyone who uses TurboTax probably wonders this."
In other words, what do you get when you pay for audit defense?
It's helpful to understand what you don't get. Typically, audit defense doesn't include:
- Legal representation in court or for criminal or civil fraud
- Bookkeeping or reconciliation of any kind
- Amending federal or state tax returns
Nearly three-quarters of IRS audits happen via letter. You've heard or read about the nightmare scenarios. But often, audits happen because of simple mistakes rather than serious fraud.
Responding to IRS letters is the main feature of these paid audit defense services.
What H&R Block and TurboTax Offer
H&R Block and TurboTax, two of the biggest tax prep software companies, each offer free versions that come with utilizing their software to create your tax return. That lets you talk to an enrolled agent who can walk you through preparing for an audit, what to expect and how to find helpful resources.
This year, the TurboTax paid program costs $39.99 on its own. (TurboTax MAX is slightly more expensive. You can only purchase it as an add-on to paid versions of the software. But it includes additional features aside from audit defense.)
In addition to responding to IRS audit letters and notices on your behalf, the paid version will explain your options and help you develop a strategy to address the audit. That includes reviewing your documentation. If your assigned pro reaches a settlement with the IRS on your behalf, you’ll also get the chance to approve or reject it.
In other words, it’s a form of limited audit insurance.
What You’d Get From a Local CPA or Tax Firm
Here’s what you’re likely to get when you look outside of a tax software company for audit defense and assistance (albeit likely at a higher price point):
- Legal representation in IRS proceedings (including in court)
- More attention toward proactive, preventative strategies when you file your taxes
- More specialized advice on your specific return and circumstances
Who Should Consider Paying for Audit Defense?
The paid version of audit defense is a profitable (perhaps quite profitable) product for TurboTax and others.
It makes sense. At one point TurboTax charged about $60 for the premium version of audit defense. If you paid a consultant out of pocket for those extra services vs. utilizing TurboTax, it may cost you a few hundred dollars.
Now consider how rare audits are. We're talking less than a half-percent of total tax returns. If you earn $200,000 or more in a year, you're more likely to get audited (same for $1 million+). Or if you own a business with $10 million in assets or revenue.
The type of person for which TurboTax is a good option (as opposed to working directly with a CPA or tax professional) are more likely to file simple, straightforward returns — and less likely to get audited.
You can also lower your chances of an audit (more on that in the next section).
Online tax software doesn’t account for inaccuracies in your own bookkeeping. If you miscalculate your deductions, for example, the tax software won’t correct you.
If you want peace of mind that your return may not be accurate, and you don’t want to scramble to hire someone out of fear if you get audited, it may be worth it for you.
Just consider the likelihood of you getting audited — and the cost for the limited insurance vs. what you’d have to pay if you don’t buy it, get audited and then have to pay someone for those same services.
How To Avoid IRS Tax Audits
Although more complex, higher-dollar returns are more likely to get audited, at least a portion of the audits happen at random.
However, if you don't fall into one of the higher-risk (higher-dollar) categories, two major issues trigger audits. There are other reasons. But just like payment history and credit utilization make up a huge portion of your credit score, you can eliminate a huge amount of audit risk by avoiding two specific land mines.
1. Excessive Deductions vs. Your Income or Profession
The IRS looks at the average deductions for specific jobs and industries. If your deductions are 20%+ higher than average, it may trigger an audit.
The same is true if your deductions are higher than usual vs. a typical person with your income and in your tax bracket.
The bottom line is to be honest and careful with your deductions. You’ll have to show proof to the IRS that they’re accurate if you get audited.
2. Missing Income
Let’s say you get a 1099 from three different companies. One of them doesn’t arrive in the mail by the time you do your tax returns and you forget to add it.
The IRS will get copies of all three. And when your return doesn’t match what they have, that can trigger an audit.
There are other, similar ways you could make a mistake when reporting income.
Pros of Tax Audit Defense
- Peace of mind. If you aren't that confident that your deductions and other portions of your tax return are accurate, it may be worth the money. You can rest easy knowing that at minimum, you'll have someone you can turn to for no additional charge who will inform you of the audit process and respond to the IRS on your behalf.
- Avoid panicked decisions in case of an audit. Clark has talked in the past about figuring out end-of-life expenses and desires while you're still living. That way your grieving family won't have to make financial and logistical decisions out of emotion (and potentially get ripped off). This isn't that extreme or heavy. But you may feel better pre-paying for audit defense so you're not scrambling to find a solution while your head is spinning the moment you get an audit notice from the IRS.
- Save time and gain confidence in responding to the IRS. If you have to respond to the IRS on your own, and you've never handled an audit before, you're likely to spend significant time looking for the right way to do things. And you may not have much confidence in figuring it out yourself.
Cons of Tax Audit Defense
- The cost-benefit analysis usually doesn't make sense. As I mentioned, you get at least some form of reassurance and help for free with the biggest tax software options. In reality, people with simple returns filing accurately are so unlikely to get audited that it's not worth paying $40 to $60. And if your return is more complex and more likely to get audited, you probably should get help from an expert beyond tax software to even file your return.
- No legal representation. Even if you get audited, most of the time it's less scary than you imagine. Simple errors can get corrected easily. Even if it means you owe a little more than you thought. But if you fall into the more severe category of audits where things get tricky legally, audit defense from a tax software company won't fulfill your needs.
- You still hold plenty of responsibility. As I mentioned, your tax software won't do any bookkeeping. So if the IRS wants you to prove your deductions are legitimate, or rectify why the investment or working income you reported is different than they expected, that's on you. You also are responsible for reaching out to your tax software company and notifying them if you do get an audit letter or notice.
Final Thoughts
You may automatically agree to audit defense from the tax software you use. It sounds like a real deal at $40 or $60. But keep in mind those companies typically offer free audit support (albeit with fewer features). And that if you get into a really sticky situation with an audit, you’ll likely still need to hire someone outside of the tax software company.
If you really want extra peace of mind, and you understand exactly what the program will and will not do for you, go for it. But in most cases, the risk/reward combo isn’t in your favor.
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