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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 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, falsified information, or other problems.

How are Returns Selected for Audit?

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

  • Abusive Tax Avoidance Transactions: Returns may be selected 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 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 of unreported income. Those returns receiving the highest scores are identified as most likely to contain errors and are selected 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: Tax returns that show financial ties between taxpayers to others under examination, such as business partners or investors, can be selected for an audit.
  • Others: The IRS may select certain tax returns as a part of local compliance projects. These projects must be approved by upper levels of IRS management.

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 carefully because it will contain important information on the audit process.

The notification letter should list the reasons your tax return was selected 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) in-person interviews and (2) by mail. The IRS is most likely to require an in-person interview when conducting an audit of a return that may have substantial errors or raised red flags.

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

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.

What are the Possible Outcomes of an Audit?

IRS audits usually conclude with one of three outcomes:

  • The IRS verifies the information you provided on your return is accurate. In that case, the IRS will end the audit without making any changes to your tax return.
  • The IRS makes changes to your tax return 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.

If the IRS finds 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 of the necessary supporting documents ready.

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 letter of the law and respects your due process rights.

Next Steps

Contact a qualified tax attorney to help you navigate your federal and/or state tax issues.

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