How an IRS Audit Works and What to Expect If the IRS Audits Your Tax Return

Ploeg and Brown P.C.

Navigating the complexities of an IRS audit can be intimidating, but understanding the process and knowing what to expect can significantly ease the burden. In this blog post, we’ll delve into the intricacies of an IRS audit, and how to navigate through one with confidence.

What Is an IRS Audit?

An IRS audit is a review of an individual’s or organization’s accounts and financial information to ensure that information is reported correctly according to tax laws and to verify the reported amount of tax is accurate. The IRS may conduct audits through the mail (correspondence audit) or in-person at an IRS office or the taxpayer’s home or business.

What Records Do You Need for an IRS Audit?

During an IRS audit, having thorough and organized records is crucial. You should be prepared to provide:

1. Income Records: Pay stubs, bank statements, investment statements, and other income sources.
2. Expense Receipts: Proof of deductions claimed on your tax return, such as medical expenses, charitable donations, and business expenses.
3. Tax Forms: All forms and documents used to file your tax return, including W-2s, 1099s, and K-1s.
4. Bank Statements: Statements that support income and expense claims.
5. Loan Agreements: Documents showing the terms and repayments of any loans.
6. Proof of Payments: Canceled checks, credit card statements, and other proof of payments.

Information Document Request (IDR)

During an audit, the IRS may issue an Information Document Request (IDR), a formal request for specific documents. An IDR outlines the documents and information the IRS needs to complete their review. It’s essential to respond promptly and accurately to IDRs to avoid further complications.

What Are the Odds of Getting Audited?

The likelihood of being audited by the IRS is relatively low. On average, less than 1% of individual tax returns are audited each year. However, the odds can vary based on several factors, including income level, the complexity of the tax return, and the presence of certain red flags.

Who Gets Audited by the IRS?

Certain profiles are more likely to be audited by the IRS:

1. High-Income Earners: Individuals with higher income levels are more frequently audited. Those earning more than $1 million annually face higher scrutiny.
2. Self-Employed Individuals: Self-employed taxpayers are more likely to be audited due to the increased potential for unreported income and improper deductions.
3. Unreported Income: Tax returns with discrepancies between reported income and what third parties report to the IRS are red flags.
4. Large Deductions: Claiming unusually large deductions, especially for charitable contributions or business expenses, can attract IRS attention.
5. Offshore Accounts: Failing to disclose foreign accounts or assets can significantly increase audit risk.
6. Cash Businesses: Businesses that operate primarily in cash are more likely to be audited due to the higher risk of unreported income.

What to Expect If the IRS Audits Your Tax Return

If the IRS selects your tax return for an audit, you will receive a notification letter outlining the scope of the audit and the required documentation. Here’s a step-by-step overview of the audit process:

1. Initial Contact: The IRS will notify you by mail. The letter will specify whether the audit will be conducted via correspondence or in-person.
2. Preparation: Gather all requested documents and records. Consider consulting a tax professional for guidance.
3. Documentation Submission: Submit the required documents to the IRS, either by mail or in-person, depending on the audit type.
4. Audit Review: The IRS reviews the submitted information and may request additional details or clarifications.
5. Audit Findings: The IRS will present their findings, which could result in no changes, a tax refund, or additional taxes owed.
6. Resolution: If you agree with the findings, you can resolve the matter by paying any additional taxes or receiving a refund. If you disagree, you have the right to appeal the decision.

Understanding how an IRS audit works and knowing what to expect can help you navigate the process with confidence. By keeping meticulous records, responding promptly to Information Document Requests, and being aware of the factors that increase audit risk, you can better prepare for an audit. If you do find yourself facing an audit, consider seeking professional assistance to ensure a smooth and fair resolution.

IRS Income Tax Audit Types

The IRS conducts different types of audits based on the complexity of the return and the issues identified:

1. Correspondence Audit: The most common type, conducted entirely by mail. The IRS requests additional documentation to verify specific items on your tax return.
2. Office Audit: Conducted at an IRS office, requiring you to bring the necessary documentation for an in-person review.
3. Field Audit: The most comprehensive audit, conducted at your home, business, or your accountant’s office. The IRS reviews your records in detail and may interview you and your staff.

Audit Process & What Audit Representation Means

The audit process typically follows these steps:

1. Initial Contact: The IRS notifies you of the audit and specifies the type and scope.
2. Document Preparation: Gather and organize all requested documents.
3. Audit Meeting: Attend the audit meeting or submit documents by mail if it’s a correspondence audit.
4. IRS Review: The IRS reviews your documents and may request additional information.
5. Final Determination: The IRS issues a report with their findings.

Audit Representation: If you’re uncomfortable handling the audit yourself, you can appoint a tax professional to represent you. This can be a tax attorney, CPA, or an enrolled agent. They communicate with the IRS on your behalf, handle all documentation, and help protect your rights during the audit process.

The IRS Tax Audit Selection Process

The IRS uses various methods to select tax returns for audit:

1. Random Selection: Some audits are chosen randomly based on statistical formulas.
2. Computer Screening: The IRS uses a computer scoring system called the Discriminant Information Function (DIF) to rate the potential for error in returns. Higher scores indicate a higher likelihood of errors.
3. Document Matching: The IRS matches information on tax returns with data from third parties, such as employers and financial institutions. Discrepancies trigger audits.
4. Related Examinations: If you’re involved in business partnerships or other entities under audit, your return might be selected for examination as well.

Types of Returns That Can Be Audited

The IRS can audit various types of returns, including:

1. Individual Income Tax Returns: Form 1040.
2. Business Tax Returns: Forms 1120 (corporations), 1065 (partnerships), and 1120-S (S corporations).
3. Employment Tax Returns: Forms 940 and 941.
4. Estate and Gift Tax Returns: Forms 706 and 709.
5. Non-Profit Tax Returns: Form 990.

How to Avoid an IRS Audit

While there’s no surefire way to avoid an audit, you can reduce your risk by:

1. Accuracy: Ensure all information on your return is accurate and complete.
2. Documentation: Keep detailed and organized records of all income and deductions.
3. Professional Help: Consider hiring a tax professional to prepare or review your return.
4. Reasonable Deductions: Avoid claiming excessive or questionable deductions.
5. Timely Filing: File your return on time to avoid attracting attention.

5 Ways to Prevent an Income Tax Audit

1. Report All Income: Ensure you report all income from all sources, including side jobs and freelance work.
2. Claim Deductions Properly: Only claim deductions you’re entitled to and ensure you have the documentation to back them up.
3. Avoid Round Numbers: Exact numbers look more accurate than round numbers, which can appear estimated and raise suspicions.
4. Double-Check Your Math: Simple math errors can draw IRS scrutiny. Use tax software or a professional to avoid mistakes.
5. Be Honest: Never falsify information on your return. The risk of penalties and interest far outweighs any potential short-term gains.

Does Amending a Tax Return Increase Your Risk of an Audit?

Amending a tax return can slightly increase your risk of an audit because the IRS will take a closer look at the changes you’ve made. However, if you discover a mistake or omission, it’s better to file an amended return than to leave the error uncorrected. When amending a return, make sure to:

1. Provide Clear Explanations: Clearly explain why you’re amending the return.
2. Include Documentation: Attach any supporting documentation that substantiates the changes.
3. File Promptly: Don’t wait too long to file an amended return once you discover an error.

By understanding the IRS audit process, knowing what to expect, and taking proactive steps to minimize your risk, you can navigate tax season with greater confidence and peace of mind.

Why Does the IRS Do Audits?

The IRS conducts audits to ensure that taxpayers are reporting their income accurately and paying the correct amount of taxes. Audits help maintain the integrity of the tax system and ensure compliance with tax laws. Key reasons for conducting audits include:

1. Verification of Income and Deductions: To confirm that income and deductions are accurately reported.
2. Detection of Errors: To identify and correct errors in tax returns.
3. Prevention of Tax Fraud: To deter and identify fraudulent activities.
4. Collection of Unpaid Taxes: To collect taxes owed by taxpayers who have underreported their tax liability.

How to Get Help for an IRS Audit

Getting professional help can be crucial when facing an IRS audit. Here’s how to find assistance:

1. Tax Attorneys: Specialize in tax law and can represent you in front of the IRS.
2. Certified Public Accountants (CPAs): Provide expert knowledge on tax preparation and audit processes.
3. Enrolled Agents (EAs): Federally authorized tax practitioners who can represent taxpayers before the IRS.
4. Tax Resolution Firms: Offer comprehensive services to handle tax issues, including audits.

What is an Audit Lawyer?

An audit lawyer, or tax attorney, is a legal professional specializing in tax law. They assist taxpayers in navigating the audit process, ensuring compliance with tax laws, and defending their rights. Key roles of an audit lawyer include:

1. Representation: Representing clients during IRS audits and negotiations.
2. Legal Advice: Providing legal advice on tax matters and audit procedures.
3. Documentation Preparation: Helping prepare and organize necessary documentation for the audit.
4. Appeal Assistance: Assisting with appeals if the audit results are unfavorable.

What If You Get a Tax Bill From an Audit and You Can’t Pay It?

If an audit results in a tax bill that you cannot pay, there are several options available:

1. Payment Plan: The IRS offers installment agreements to pay the tax debt over time.
2. Offer in Compromise: You may settle your tax debt for less than the full amount owed if you qualify.
3. Currently Not Collectible Status: If you can’t pay due to financial hardship, the IRS may temporarily delay collection efforts.
4. Appeal: If you disagree with the audit findings, you can appeal the decision.

How to Request an Audit Reconsideration

If you believe the results of your audit are incorrect, you can request an audit reconsideration. Here’s how:

1. Gather Evidence: Collect new or additional evidence that supports your position.
2. Submit a Request: Write a letter to the IRS requesting reconsideration. Include your evidence and explain why you believe the audit results are wrong.
3. IRS Review: The IRS will review your request and the new evidence. They may adjust their findings based on the additional information provided.

IRS Tax Audit Representation: Audit Defense

Audit defense involves representing and defending a taxpayer during an IRS audit. Professional representation can make a significant difference in the outcome of an audit. Here’s what audit defense typically includes:

1. Representation: A tax professional represents you during all interactions with the IRS.
2. Documentation Management: Organizing and submitting all required documents to the IRS.
3. Negotiation: Negotiating with the IRS on your behalf to resolve any issues.
4. Appeals: Assisting with appeals if you disagree with the audit results.
5. Strategy Development: Developing a defense strategy tailored to your specific situation

For expert assistance and comprehensive audit defense, contact our experienced Tax Expert team at Ploeg and Brown P.C. We are dedicated to helping you navigate the complexities of IRS audits and ensure your rights are protected.