So, You’re Being Audited by the IRS…

Contrary to popular belief, IRS audits are actually a very rare occurrence in this day and age. Statistically, the average citizen has a less-than-1% chance of being audited by the IRS. Even still, being audited is not the end of the world. It doesn’t even necessarily mean that you owe money to the IRS.

According to the Internal Revenue Service’s official description, an audit is “a review/examination of an organization’s or individual’s accounts and financial information to ensure information is reported correctly according to the tax laws and to verify the reported amount of tax is correct.”

An audit is not a bill. If the auditee can provide proper documentation about the tax return in question, everyone goes home happy. The IRS has their answers, and the auditee owes nothing. An audit will only become a bill if the discrepancies are found and agreed upon by both parties, or if the auditee either doesn’t respond to the IRS’s requests or doesn’t provide adequate records that support the original tax return.

An IRS audit doesn’t always mean there’s a problem. How the IRS conducts an audit also depends on the severity of the situation. Knowing how and why you’re being audited will help you determine your best course of action.

How Does the IRS Conduct Audits?

There are two main ways in which the IRS will conduct an audit. One is by correspondence, and the other is face-to-face. However, realistically there are four different ways in which the IRS can carry out an audit, based on the severity of the situation.

  • Correspondence Audit: The most common type of audit is a correspondence audit. This type is a mail-audit process which requires you to send proper documentation to an IRS office by specific deadlines. In this case, actively staying involved in the process is crucial. Stay on top of deadlines, make sure you provide ALL of the requested documentation in the right format and maintain regular contact with the IRS. Correspondence audits will only occur through the mail. The IRS will never initiate an audit via telephone.
  • Office Audit: Also known as a “desk audit,” an Office Audit is one of two ways that the IRS will conduct a face-to-face audit. In this scenario, the IRS will ask you to bring all requested documentation and proof to your local IRS office. An IRS agent will conduct the audit at their office. Office audits typically take up to 2 hours.
  • Field Audit: A field audit is a rare case where an IRS agent comes directly to your house or your business office to conduct the audit in person. Unlike Office Audits, Field Audits can take up to an entire day to conduct. The more complex the audit, the longer it will take and the more follow-up requested may be made before final audit approval.

Why Am I Being Audited?

There are several reasons why you might be on the receiving end of an audit. The IRS is always updating and re-evaluating their tax check systems. Through data algorithms, the IRS develops “norms” for a given tax return. Your tax return is then compared to these “norms,” looking for inconsistencies or red flags.

However, sometimes an audit is performed as a check on the validity of their “normal” data. Other times, auditing one person or business may result in the IRS auditing other related tax returns. The following are four main reasons why the IRS may audit you.

  • Random Selection (Computer Screening): This audit is a result of simple statistical randomization. Like being chosen to retake your driver’s test or show up for jury duty, a computer-screened random selection audit occurs through no fault of your own and should (hopefully) be nothing to worry about. Providing the proper documentation to support your tax return should be enough to verify the numbers and satisfy the IRS.
  • Related Examinations: If your finances are in any way connected to another person/business being audited by the IRS, it is possible that the IRS may also audit you. If your tax return shows transactions with another being audited, you might want to have your tax documentation on hand. If your transactions are all documented and verifiable, you should have nothing to worry about.
  • Return Mismatches: The IRS will question any discrepancies between your submitted tax return and the official documentation they have on file. These files include things like W2 and 1099 forms. In the case of a mismatched return, you will receive a CP2000 Notice from the IRS asking you to explain the differences.
  • Audit Triggers: The most common reason the IRS conducts an audit is that something has signaled a red flag in their system. These are known as “audit triggers,” are complex search criteria the IRS uses to question the validity of certain types of tax returns more accurately.

What Are Audit Triggers?

Audit Triggers are automatic red-flag alerts for the IRS. These triggers are put in place to help streamline the processing of millions of tax returns each year. These triggers may occur for several different reasons. As long as you can provide the appropriate documentation when prompted by the IRS, then you will receive no fines. However, if the triggers result in the IRS changing your tax return, you may owe money and potentially serve jail time. Here are several common Audit Triggers.

  • Incorrectly reporting taxable income
  • Tax errors/incorrect math
  • Round, whole numbers (no decimals)
  • Homebuyer tax credits
  • Claiming a home office
  • Using a personal car for business
  • Reporting business losses for several years in a row
  • Claiming large charitable donations inconsistent with your income
  • A large increase in income from the previous fiscal year
  • Claiming losses from hobbies or things otherwise considered non-professional
  • Connections to foreign bank accounts
  • Deducting meals and entertainment
  • Being Self-Employed
  • Owning/operating a cash-only business
  • Overlooked forms of income not claimed on a tax return

What Do I Need to Provide to the IRS?

Once the IRS initiates an audit, they may request several different types of documentation and proof to help facilitate the process. They will provide you with a written list of documents needed to prove or disprove the tax return discrepancies. Some electronic files are accepted already, with more becoming acceptable each year as the digital age advances, but many instances still require hard copies and paper documentation.

Contact your auditor to find out what form is required for each document. The IRS should provide you with a written list of all documents needed and in what form they accept them. The IRS may also require you to fill out a questionnaire for more information. Here is a list from the IRS’s website of many typical examples of what an auditor may request.

  • Receipts
  • Bills
  • Canceled checks
  • Legal papers
  • Divorce settlement paperwork
  • Criminal or civil defense papers
  • Property acquisition documents
  • Tax preparation paperwork
  • Loan agreements
  • Logs or diaries
  • Tickets
  • Medical and Dental records
  • Theft or loss documents
  • Employment documents
  • Schedule K-1

What Is The Best Course Of Action?

First and foremost, you should know your rights as a taxpayer. Knowing is half the battle and the more you know, the better prepared you will be for anything tax-related.

Secondly, if you didn’t file your own taxes, you should contact the tax advisor who prepared your tax return immediately upon receiving an audit letter from the IRS.

If you are still worried, confused, or intimidated by the IRS audit process, or if your audit is a face-to-face Office or Field Audit, you should consider hiring a tax lawyer to help navigate you through the process.

For any help regarding tax preparation, submitting tax returns, or IRS audits, contact Volpe Consulting & Accounting today for a free consultation!

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