Understanding Tax Audits
What is an IRS tax audit?
You may have heard of the term “audit” across other areas of your life. Still, when it comes to paying taxes, a tax audit is when the Internal Revenue Service takes a closer look at your tax return and analyzes the accuracy of the details in which you have provided. Usually, the IRS decides to audit an individual when there are details in your tax return that are out of the ordinary.
If you ever find yourself subject to an IRS tax audit, educating yourself on the reasons for receiving IRS audits and the different types of tax audits can help you prepare for any complications you may face. Additionally, consulting with a professional tax attorney at Ideal Tax can help individual taxpayers resolve tax issues when they owe money to the IRS.
Key Takeaways:
An IRS tax audit is when the IRS conducts a close analysis of your tax return to verify the accuracy of the details you have provided regarding income and deductions.
The IRS randomly selects individuals for tax audits to develop “norms” for similar tax returns.
The IRS may issue an audit letter when an individual’s tax return involves issues or transactions with other taxpayers who are being audited.
You may also receive an audit notice if you report irregular income, have substantial income, possess foreign assets, or are involved with a cash-intensive business.
The IRS will never contact you by telephone, but will always contact you by mail.
A correspondence or mail audit notice can be resolved by providing additional documentation and without meeting with revenue agents in person. An office audit involves meeting with IRS revenue agents at an IRS office in your area to answer questions and provide additional tax information. A field audit involves IRS revenue agents visiting your house or business location to ask questions and request additional information about your tax returns.
The Taxpayer Compliance Measurement Program is when the IRS issues an audit to randomly-selected tax returns to evaluate compliance with tax laws and how much revenue is lost due to non-compliance.
The best way to prepare for IRS audits is to maintain meticulous bookkeeping throughout the tax year and keep copies of financial documentation and receipts. This makes it easier to file a tax return and provide proof to the IRS revenue agents during the situation you are audited.
If you receive an IRS audit, the four steps you must take include understanding the scope of the audit, preparing a response to the IRS letter, responding to the audit accordingly and in a timely manner, and appealing the audit if you disagree with the decision.
Who gets selected for an IRS audit?
There is more than one reason that an individual may be selected for an IRS tax audit, and just because you receive an audit letter does not mean that there are complicated tax issues that must be resolved. However, there are instances in which you may be at fault. While a large number of taxpayers who are selected for an audit are chosen randomly, there are some factors that can increase the likelihood of being audited.
How Far Back Can The IRS Audit?
The IRS generally has three years to audit a return, although there are some exceptions. For example, if the IRS believes that a taxpayer has intentionally underreported their income, they have up to six years to audit the return.
Additionally, if a taxpayer fails to file a return, the IRS has an indefinite period of time to audit the return. As a result, it is important to ensure that all returns are filed promptly and accurately.
If you have any questions about your tax liability, it is advisable to speak with a tax professional. By doing so, you can help to minimize the risk of an audit and resolve any issues that may arise.
Some of the methods the Internal Revenue Service utilize to determine to who they issue audits include:
Random Selection
Sometimes the IRS utilizes random selection solely using statistical formulas to determine who will receive an audit notice. During this IRS examination process, the auditor compares your tax return to the “norms” of other similar tax returns. Developing these “norms” using audits of a statistically random sample of tax returns allows IRS examiners to more easily review inventory records and understand which complex tax returns are valid.
Related Examinations
The IRS may issue an audit letter when an individual’s tax return involves transactions or issues with other taxpayers. This could include investors or business partners whose returns were selected by revenue agents for an audit. In this instance, the examination report requests additional financial information to verify the validity of the information reported across multiple tax refunds.
Incomplete Income Reports
You may be issued an IRS notice about your tax return being audited if the total positive income you report is incomplete. When filing a tax return each tax year, the IRS requires that you include all forms of income, including earnings from wages, tips, salaries, bonuses, personal income, business income, property income, child support, and more.
Inconsistencies in Business Operations
Sometimes the IRS is triggered to issue a tax audit when a business reports inconsistencies in its tax return, identifies unusual business expense deductions for entertainment and meals, or a sharp drop in income is reported across each tax year.
Large Charitable Deductions
Although donating a large sum to a charity may cause you to receive an IRS letter about a tax audit, this can often be quickly resolved when you can provide proof of the transaction to the Internal Revenue Service. This is an example of why it is crucial for taxpayers to maintain meticulous bookkeeping records, including keeping copies of receipts.
Having Substantial Income
For some people, all it takes to be noticed by the IRS is making a large income each year. A majority of tax returns that are audited each year belong to taxpayers who earn more than $500,000 a year – especially when those individuals attempt to write off a large sum of their tax payments through deductions. In short, the larger your income, the more important it is to keep diligent records of your tax and financial documentation in preparation for potential IRS audits.
Foreign Assets
Another factor that may trigger an IRS officer to issue an audit notice is when someone has money saved in a foreign bank account. The uniqueness of the situation alone can be enough for the IRS to request additional information to determine whether your tax return is accurate when you keep money in a foreign bank account.
Cash-Intensive Businesses
When payments are made electronically during business transactions, it is easy to keep track of the movements of funds, but when businesses utilize a large number of cash payments, it becomes more complicated to ensure financial documentation is accurate. Examples of cash-intensive businesses that may be more likely to receive a tax audit include restaurants and convenience stores whose total positive income is accumulated from many smaller cash transactions.
How Taxpayers Are Notified About IRS Audits
If you are ever subject to an IRS tax audit, it is beneficial to be aware of the methods by which the Internal Revenue Service will reach out to notify you about the auditing process. It is especially important to note that IRS auditors will never notify an individual about tax compliance information over the telephone. If you receive a phone call from someone claiming to be an IRS manager, do not reveal any personal information.
There are four main types of IRS audits, including mail or correspondence audits, office, and field audits, and Taxpayer Compliance Measurement Program audits.
Below, we will explore each of these:
Correspondence Audit or Mail Audit
The mail service is the most reliable form of communication the IRS office utilizes to issue audits and enforce the internal revenue code, so no matter what type of audit you receive, you will always receive notification via mail. Out of all the types of IRS tax audits, correspondence audits, also known as mail audits, are the simplest, because they do not necessarily require that you meet with an IRS auditor in person. Instead, you can usually resolve correspondence audits by sending documentation in the mail. Although it is ideal for your tax return to be accepted without being questioned by the Internal Revenue Service, a correspondence audit is often convenient to resolve and nothing to worry about.
In the case that you receive a correspondence audit from the IRS, they will typically be requesting additional forms of documentation to provide details about items you report on your tax return. An example of supporting documentation that could be requested during IRS correspondence audits could include proof of charitable donations when you have reported charitable deductions on your tax returns. Generally, if the IRS agent deems your supplemental documentation provides sufficient proof of your reported actions, correspondence audits can be considered concluded.
Office Audit
Compared to a mail audit that does not require a taxpayer to meet with an IRS auditor, an IRS office audit involves an in-person audit at a local IRS office. When you receive an office audit, the IRS officer will take a more in-depth look at the information reported on your tax returns, including asking you questions about this reported information.
During office audits, you may be required to bring with you supporting documentation and financial records, including business-reported data, personal bank statements, and receipts. Additionally, you have the right to bring an accountant or tax attorney from a law firm to support and represent you during an office audit.
Field Audit
A field audit is the vaguest type of IRS audit. Compared to office audits that are conducted at a local IRS office, field audits take place in your own home or business location. A field audit is an extremely thorough type of tax audit that often question more than one of the itemized deductions listed in your tax returns. Usually, field audits will cover and analyze most, if not all, items on your tax return.
Taxpayer Compliance Measurement Program Audit
The Taxpayer Compliance Measurement Program (TCMP) is conducted by the Examination Branch of the Internal Revenue Service to gather an estimate of how taxpayers comply with tax laws and how much revenue is lost due to noncompliance. During a TCMP audit, data is gathered using audits of randomly-selected tax refunds to evaluate the efficacy of the current tax law and offer potential suggestions for improvements to overall tax processes. A TCMP audit is an important aspect of IRS research because it provides information about how individuals manage their tax preparation.
Compliance measurement research is also known as the tax gap. The tax gap focuses on noncompliance with tax law and examines the extent to which tax payments are not made in a timely and voluntary purpose.
How to be prepared for an IRS audit
You can prepare for an IRS audit by being diligent about keeping detailed bookkeeping records and organizing your financial and tax documentation. When you keep detailed documentation of your financial records throughout the tax year, you will be more likely to accurately fill out your tax return and determine the amount of taxes owed to the IRS. Not only will meticulous bookkeeping make the process of filing a tax refund easier, but it will also be a simple process to provide information to tax attorneys at a law firm if you are ever issued an audit notice.
Internal Revenue Service audits involve the analysis of individual income tax returns, so when you have organized all of your accounting procedures, the process of communicating with the IRS agents will be seamless and simple. To make the process even less stressful, consulting a tax professional such as a tax attorney at Ideal Tax can help you feel confident as you navigate the tax law and negotiate with the Internal Revenue Service.
What To Do When You Are Audited By The Internal Revenue Service
In the case that you are audited by the IRS, you don’t need to panic about what to do. There are just a few steps that you need to follow to take care of your IRS audits once and for all.
Understand the scope of your audit.
If you have received an audit notice for the IRS, a good first step is to read the entire letter to understand what the IRS is requesting from you. The letter will describe which information you need to provide, how to contact an IRS representative and the deadlines for providing the supplemental financial documentation.
If you receive a correspondence audit through the mail, you may be able to resolve your tax issues without consulting a tax professional. However, if you receive an office or field notice, it is highly recommended that you consult with an accountant or tax expert to represent you when negotiating with the IRS.
Prepare your response to the IRS letter.
If you received mail audits, the tax preparer may only need to gather the requested documentation in response to the items the IRS is questioning.
For office and field audits, you should prepare for your meeting with IRS auditors by gathering financial documentation, preparing for possible questioning about unexplained items on your tax return, and accounting for all financial transactions you have been involved with throughout the tax year.
Respond to the IRS request accordingly.
If the IRS believes there is an adjustment to your tax return, they will request proof of financial records through an Information Document Request. Once you have gathered your supporting documentation to provide proof for the items you have listed on your tax returns, you must respond to the IRS by their requested date and with the required information in order to advocate your tax return positions.
If the IRS disagrees with any information on your tax return, such as thinking that you should have reported more income on your return or that you listed an inappropriate deduction, they may audit you. If you disagree with the Internal Revenue Service’s claims, you must present your case with sufficient proof. It is beneficial to utilize tax experts at a law firm to help advocate for your rights when negotiating with the IRS.
The IRS will ultimately close the audit, agreeing to your appeal or proposing adjustments to your return. The report of findings will be delivered to you in what is called a 30-day letter from the IRS because you have 30 days upon receiving the letter to appeal the case if you disagree.
Appeal your audit, if you disagree.
If you decide that you disagree with the IRS audit, you can request an appeal with the IRS Office of Appeals as long as it is within the 30-day deadline listed on your audit letter. After this period has passed, the IRS will issue a letter known as a Statutory Notice of Deficiency that closes the audit and allows you to petition the U.S. tax court.
Do I need to hire a tax attorney when I receive an IRS audit?
Navigating the nuances of the United States tax law can be confusing for the average taxpayer, but if you are facing an auditing situation from the Internal Revenue Service, hiring a licensed tax attorney can give you the confidence you need to resolve your IRS audits without the stress. The Taxpayer Bill of Rights describes an individual’s right to hire representation when receiving an audit, and although not all auditing situations require the support of a tax expert, it can be helpful to ensure you are responding to the audit completely and accurately.
There are several benefits of hiring tax attorneys to help you when you are audited. If you are unclear about the auditing process or unable to provide accurate documentation, a professional can provide guidance and help you strategize. Tax experts can also help those who are too busy to engage in communication with the IRS. Additionally, professionals can advocate for the taxpayer with an in-depth understanding of tax laws so you can be confident that you are managing your situation appropriately.
If you are being audited by the Internal Revenue Service, contact the tax professionals at Ideal Tax today.
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