Audit Protection Racket

Someone might ask, "Hey, Bill, why don't you get into the audit protection racket?" Because it's a racket, I would reply.

On average, 3% or so of the tax returns filed in a year are audited. Averages are deceiving. If all your income is from W-2s, interest and dividends then your chances of being audited are probably immeasurably small (not counting those notifications by mail that you left out the interest reported on a 1099).

So what about these outfits offering "audit protection?" They claim for a low monthly fee that they will represent you if you're audited by the IRS. For example, one of them offers four plans, the 2nd lowest cost one being what they call their "Premium" plan. If you're audited, you get up to 20 hours of a professional's time to deal with the IRS on your behalf. To get that "protection," you pay $12.95 per month.

Let's do what accountant's do. Let's run the numbers. Let's assume that 100 people buy that "Premium" coverage which means the provider takes in $1295 per month or $15,540 per year. A generous assumption would be that 2 of those returns would be audited during the year. The audits I've handled required 4 or 5 hours of my time but let's assume the average here is 7 hours and the provider's hourly cost including direct overhead items is $300 per hour. That means $4,200 go out. Gross profit on the year from those 100 suc... er .. clients is over $11,000.

Each individual pays about $155 per year for "audit protection" (but see below). If the taxpayer passed on this deal and just hired a CPA or EA if and when he/she were actually audited, the cost would probably be less than $2,000 and often a lot less. You would have to be audited about every 12 years, about four times the average, to be money ahead on this deal.

Besides 20 hours of audit defense time and 60 minutes of telephone time, the "Premium" package also says you get $5,000 of "Audit Protection." What is that? I'll tell you what the seller wants you to think. They want you to think they will pay the first $5,000 of any balance due if you get audited. Don't think that because it is NOT true. If you dig into the membership agreement you learn that $5,000 is the maximum value of the services they will provide you if you're audited.

In general, the IRS has three years to audit a properly filed tax return. If you filed your 2008 tax return on or before the April 15th 2009 due date, the IRS has until April 17th of this year to initiate an audit (unless you failed to report a bunch of income in which case they have until April 15, 2015). For most situations, if your 2008 return was going to be audited you would have found out about it in 2010 or 2011 at the latest.

Here's another gotcha. The membership agreement defines "covered return" as "a tax return for a single tax year in which the member was active and in good standing with us and at the time of such Internal Revenue Service Audit the member was and is currently an active member in good standing." What does that mean if you joined up today? First, it means tax years occurring before you joined aren't covered. You didn't join in 2011 so 2011 and earlier years aren't covered. Second, even though 2012 would apparently be covered you have to maintain your membership until that year is actually audited or you're not covered after all. So, scratch that $155 above. It's really going to cost you about $310 to have 2012 covered and you probably won't be audited anyway.

There you have it. These guys are offering a better deal (for themselves) then selling extended warranties on electronic goods or running a casino.

One more thing, these audit protection outfits have a very poor track record of actually providing the promised services to their clients that are actually audited. You pay your money, you get audited, you inform your audit protection company, they do nothing, the IRS hasn't heard from you or anyone else and concludes you're a scofflaw, you pay the IRS even more than the original assessment, the racketeer goes on to the next victim.