What Is a Tax Audit?
Many Americans live in fear of an IRS audit, even those who try to comply with the law and pay everything they owe. Much of this fear is based on the worst-case scenario horror stories that we hear from friends and family about the bad outcomes that will often result when someone is found to have cheated the IRS.
But the reality of a modern IRS tax audit is often very different. In fact, the IRS has been conducting nearly two-thirds of its audits by mail and, in most cases, the IRS is only asking to verify information, like your income, dependents, and eligibility for credits.
However, even an IRS audit conducted by mail must be taken seriously. Any IRS audit can have significant consequences and lead to you paying thousands of dollars in past-due taxes, penalties, and interest. In the following sections, we will review the basics of an IRS audit, how they should be handled, and your taxpayer rights.
Tax Audits: The Basics
A tax audit is a formal examination conducted by the IRS to verify information or uncover inaccurate tax returns or fraud. The IRS selects tax returns to examine both randomly and based on apparent irregularities in the returns that have raised questions. If the audit is selected at random, the IRS will simply take a closer look to make sure all the information is accurate. Non-random audits are usually conducted when the IRS flags a return for errors, incomplete information, or possible fraud.
The IRS usually sends out an audit notification by mail for the following reasons:
- You have a balance due
- You are due a larger or smaller refund
- The IRS has questions about your tax return
- The IRS needs to verify your identity
- The IRS needs additional information
- The IRS changed your tax return
- The IRS needs to notify you of delays in processing your return.
IRS tax audits can be broken down into four different types:
- Correspondence Audits: This is the least serious type of tax audit. A correspondence audit refers to the IRS request for additional information to verify your tax return's accuracy or details.
- Office Audits: An office audit refers to the in-person interview with an IRS manager to process your audit. To avoid making statements that can be used against you, it's highly advisable to consult with an attorney or a tax professional before you attend the interview.
- Field Audits: This is the most serious type of audit because the IRS agents will visit you at home or business. They may ask to see things that are related to the tax you've reported.
- Random Audits: As mentioned above, tax returns can be randomly selected for an audit. A random audit is made without any particular reason. The IRS auditor will review the entire tax return to make sure the information was entered correctly.
How To Handle Your Tax Audit
For all types of audits, the IRS begins the audit process by sending a notification letter to the taxpayer. If you've received a notification letter, you should first read the letter carefully because it will contain important information. That information will include the reason why your tax return is being examined, specific steps to follow, and the deadline for replying.
You should then prepare to resolve the issue by researching the law and gathering the necessary information. Don't feel rushed to contact the IRS to respond to the letter because any information you give to the IRS may be used against you. If you need more time to gather information or prepare yourself to respond, you can submit a written request to the IRS by fax or mail to get a one-time 30-day extension. However, if you've received a "Notice of Deficiency" in the mail, the IRS won't grant you an extension.
There are three possible ways of concluding an audit:
- An audit can conclude without making any changes when the IRS accepts the documents or information you've submitted.
- The IRS proposes a change to your tax return and you agree to those changes.
- You disagree with the proposed IRS changes and request a conference with an IRS manager to challenge its assessment.
Your Taxpayer Rights
Taxpayers have the right to know what steps to take to comply with the tax laws. The Taxpayer Bill of Rights requires the IRS to provide taxpayers with clear explanations of the laws. There are several rights, and these rights apply to tax audits as well. The IRS informs its employees and the taxpayers that the taxpayers have the following basic rights:
- A right to professional and courteous treatment by IRS employees
- A right to privacy and confidentiality about tax matters
- A right to know why the IRS is asking for information, how the IRS will use it, and what will happen if the requested information is not provided
- A right to representation, by oneself or an authorized representative
Be Prepared for Your Audit: Call a Tax Attorney
Some tax audits are conducted to resolve relatively simple issues, but others can be complex and involve extensive documentation of your spending over a period of years. In most cases, you only need representation during a tax audit if you are facing penalties or possible criminal prosecution for tax crimes.
To be safe, before responding to the IRS, you should first analyze the status of your tax return and determine what steps to take to resolve the matter. If it does not seem to be a simple misunderstanding that could be cleared up quickly, or the IRS has notified you of a significant deficiency, you should contact an experienced local tax attorney to protect your rights during the audit process.