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What Is a Tax Audit?

Many Americans fear an Internal Revenue Service (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 we hear from friends and family about the bad outcomes that may result when an audit finds someone cheated the IRS.

The reality of a modern IRS tax audit is often very different. The IRS has been conducting nearly two-thirds of its audits by mail. In most cases, the IRS only asks to verify information like your income, dependents, and eligibility for tax credits.

However, you must take even an IRS audit conducted by mail 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 to handle it, and your taxpayer rights.

Tax Audits: The Basics

An income tax audit is a formal examination conducted by the IRS to verify information, uncover inaccurate tax returns, or look for fraud. The IRS selects income tax returns to examine through random selection and based on apparent irregularities in the returns that have raised questions about your tax liability.

If the audit is selected at random, the IRS will take a closer look to ensure all the information on your return is accurate. Nonrandom audits occur when the IRS flags a return for errors, incomplete information, or possible fraud.

The IRS usually sends out an audit notice by mail for the following reasons:

  • You have a tax due
  • You are due a larger or smaller tax refund
  • The IRS has questions about your tax return
  • The IRS needs to verify your identity
  • The IRS requires additional information
  • The IRS changed your tax return
  • The IRS needs to notify you of delays in processing your return

The four different types of IRS tax audits are:

  • 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 an in-person interview with an auditor in an IRS office. It's highly advisable to consult with an attorney, CPA, or an enrolled agent before you attend the interview. This ensures you don't make statements the IRS can use against you.
  • Field Audits: This is the most serious type of audit because the IRS agents will visit you at your home or place of business. They may ask to see things related to the tax you've reported.
  • Random Audits: As mentioned above, the IRS randomly selects tax returns for audit. A random audit happens without any particular reason. The IRS auditor will review the tax return to ensure the information was entered correctly.

How To Handle Your Tax Audit

The IRS begins the audit process for all types of audits by sending a notification letter to the taxpayer. If you've received a notification letter, you should read it carefully because it will contain important information. That information will include why your tax return is under examination, the tax year under review, specific steps to follow, and the deadline for replying.

Prepare to resolve the issue by researching the law and gathering the necessary information. Usually, you use this information to prepare your tax forms and prove that you are entitled to any deductions or credits you claimed, such as bank statements, receipts, retirement account statements, broker statements, and other financial information.

Generally, the statute of limitations for examinations of tax returns is three years. That means the audit period is usually the past three tax years. However, for large understatements of income, the amount of time the IRS has to review your returns is six years. There is no statute of limitation if you did not file any returns or filed fraudulent returns.

The notification letter will include the contact information of the IRS staffer conducting the audit. But don't feel rushed to respond because any information you give to the IRS may be used against you. If you need more time to gather information or prepare to respond, you can submit a written request to the IRS by fax or mail for a one-time 30-day extension. However, the IRS won't grant you an extension if you've received a Notice of Deficiency in the mail.

What Happens After an Audit?

There are three possible ways of concluding an audit:

  • An audit can end without making changes when the IRS accepts the documents or information you've submitted.
  • The IRS proposes a change to your tax return, and you agree.
  • 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. Several rights also apply to tax audits. 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 you don't provide the requested information
  • A right to representation by oneself or an authorized representative

Be Prepared for Your Audit: Call a Tax Attorney

Some tax audits 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 the representation of a tax professional 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.

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