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The Tax Return Audit Process

No matter how careful you are when you fill out your federal income tax return, the IRS (or a state department of taxation) can still choose your return for a tax audit. That is because the Internal Revenue Service (IRS) has the authority to randomly select your tax return even if there is no apparent problem.

Of course, the IRS also selects returns for audits because they raise one or more red flags due to missing information, unreported income, an overly large tax refund, falsified information, or other problems. Filing an amended return does not trigger an audit.

Taxpayer's Right to Representation

The tax code includes a provision covering taxpayer rights. Among those rights is the right to retain authorized representation when dealing with the IRS audit process. However, only a limited number of individuals can practice before the IRS. These include:

  • Tax attorneys
  • Certified public accountants (CPAs)
  • Enrolled agents who have either passed an enrollment test or are former IRS employees

Note that unless they are CPAs, most tax preparers are not authorized to represent you during an audit. This means that in most cases, if a tax professional prepared your return, you can't rely on them to guide you through the audit process.

You can also choose to represent yourself.

How Are Returns Selected for Audit?

The purpose of an IRS audit is to verify the accuracy of the information reported on your federal income tax return. The following are among the most common reasons the IRS will choose a return for an audit:

  • Abusive Tax Avoidance Transactions: The IRS may select returns if the taxpayer participated in a transaction that had the primary purpose of avoiding or evading taxes.
  • Computer Scoring: The IRS uses two computer systems that use random selection to choose returns to analyze potential errors and calculate numeric scores. The Discriminant Function System (DIF) score indicates the potential for changes. The Unreported Income DIF (UIDIF) score indicates the potential for unreported income. The IRS identifies those returns receiving the highest scores as most likely to contain errors, and they will select these returns for audit.
  • Large Corporations: The IRS has traditionally elected to audit the returns of many large corporations every year.
  • Information Matching: If the income reported on the tax return and the income from payer reports do not match, it raises a red flag. The IRS will select these returns to find possible errors or fraud.
  • Related Examinations: The IRS can select tax returns that show financial ties between taxpayers to others under examination, such as business partners or investors, for an audit.
  • Others: The IRS may select certain tax returns as a part of local compliance projects. Upper levels of IRS management must approve these projects.

The IRS has a three-year period from the time a tax return was due or filed to assess any additional tax. This statute of limitations prevents the IRS from conducting audits more than three years after the returns were filed.

Audit Notification Letters

Before conducting any tax audit, the IRS sends out notification letters to the taxpayer. If you've received a notification letter, be sure to read it carefully. It will contain important information about the audit process.

The notification letter should list the reasons the IRS selected your tax return for an audit, provide instructions for what you need to do, and give you a deadline for responding. If you need additional time to reply, you may request a one-time 30-day extension from the IRS.

How Are Audits Conducted?

There are two different ways the IRS conducts tax audits: (1) by mail; and (2) in-person interviews. The agency is most likely to require an in-person interview with an IRS agent in some cases. The IRS can require this when conducting an audit of a return for individual or business taxes that may have substantial errors or raised red flags.

For less serious types of audits, the IRS will communicate with you by mail without meeting in person. These are referred to as “correspondence audits" and generally involve requests for additional information to verify the accuracy of your tax return. As long as you supply the proper documents during the correspondence audit, the IRS will not require an in-person interview.

In-person interviews generally fall into two categories: office audits and field audits. The IRS conducts office audits in their offices, whereas the IRS conducts field audits in your home, your place of business, or the office of your accountant or attorney. To prepare for an in-person interview, you should gather all the necessary tax information, including your bank account information and tax forms from previous years.

The IRS will assign a time, place, and method for the interview. In-person interviews aren't used for most audits. But the IRS may require one if it suspects that you or your business were involved in tax fraud or other criminal activities.

What Are the Possible Outcomes of an Audit?

IRS audits usually conclude with one of three outcomes:

  • The IRS verifies the accuracy of the information you provided on your return. In that case, the IRS will end the audit without making any changes to your tax return.
  • The IRS makes changes to the amount of tax due, and you must pay additional taxes, interest, or penalties. If you accept those changes, you will simply pay the outstanding balance. In some very limited cases, the IRS will find you overpaid on your taxes, and you will get a refund.
  • The IRS finds that your returns show evidence of tax evasion or tax fraud. If your audit shows you committed either offense, the IRS will refer your case to the U.S. Department of Justice's Tax Division for possible prosecution.

At the conclusion of the audit, you will receive an audit report from the IRS. The examination report explains the audit findings and whether they resulted in increased tax liability. If the audit results show you owe additional taxes, penalties, or interest, you may contest its conclusions and request an in-person conference with an IRS manager. Before meeting with the manager, you should prepare yourself to challenge the assessment by having all the necessary supporting documents ready.

Right to an Appeal

If you are unhappy with the results of your audit and the IRS's determination of your tax liability, you always have the right to appeal to an independent arbiter. That gives you the option of appealing the audit determination to the IRS appeals office, the U.S. Tax Court, or the federal court for your jurisdiction.

Facing an Audit? An Attorney Can Help

You do not need to hire an attorney for most types of audits. If the IRS audit letter says that it is simply seeking additional documentation or verification, then you can probably handle the correspondence audit yourself.

However, if the letter says the IRS is investigating more serious issues, you should contact a local tax attorney for help. An experienced tax attorney understands the audit process and will represent you throughout the proceedings to ensure the IRS follows the tax laws and respects your rights.

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