Just hearing the words “IRS tax audit” can cause someone to panic. And, if that person really does get an audit notification from the IRS, that fear can then cause him or her to freeze, instead of taking the actions that would be beneficial to resolve the issues.
So, whether you’ve already received notification that you’re being audited, or if it’s a fear you have, it’s important to understand the nuts and bolts of IRS tax audits, including:
- The definition of a tax audit
- How the IRS chooses to audit someone
- Seven red flags that can trigger an audit
- How to respond if you’ve been selected to be audited
- How the audit process works
- Why getting professional representation is important
If you have questions about your specific situation, simply contact Key Tax Group online or call (800) 380-7085.
Definition of a Tax Audit
In and of itself, a tax audit is simply the IRS doing a double check on the numbers you’ve provided on your tax return to make sure no discrepancies exist. Their goal is to reduce the gap between what the IRS is actually owed and what is being reported and paid to them. That innocuous-sounding definition, though, isn’t likely to comfort you if you’re the one being audited, even if you know you’ve provided all the information on your return in good faith, with belief in its accuracy.
How the IRS Chooses Whom to Audit
The IRS lists two common ways that they select tax returns for auditing:
- Random selection and computer screening: this can mean your return was chosen “based solely on a statistical formula,” which means your return was compared against similar returns and then chosen because of certain characteristics
- Related examinations: your return may be chosen because of its connection to returns of other taxpayers whose returns are being audited; this can include business partners or investors, as two examples; further on, we’ll discuss how this can also include your ex-spouse
An experienced auditor then reviews returns that were selected for audit. He or she may say all is acceptable as filed and, in that case, the audit process never really goes into effect, or something questionable may be noted; in the latter case, the return will be forwarded to an examining group for further review.
And, a percentage of tax returns are selected for auditing because of red flags contained within the returns themselves. So, to reduce your chances of an IRS audit, there are certain red flags to avoid or, in some cases where you can’t change the situation, at least be aware of.
Seven Red Flags
This is not a complete list of potential triggers, only some of the most common.
Red Flag 1: Falling into a Certain Income Bracket
NerdWallet.com provides a useful chart that breaks down the percentage of audits that occur in each of more than one dozen tax brackets. If for example, you report one million dollars or more in income, there is a 33.85 percent chance you will get audited, based on 2016 figures. If you report no adjusted gross income whatsoever, there is a 3.25 percent chance you will get audited. People who fall into these categories are the most likely to be audited, but they aren’t the only ones.
Let’s say you earn between $75,000 and $99,999. In 2016, .52 percent of people reporting that income range were audited, which is slightly more than one audit in every 200 returns. If you reported between $100,000 and $199,000 in income, the risk is a bit higher: .62 percent.
And, here’s the bottom line: if you get audited, it can feel very intimidating, no matter what tax bracket you fall into.
Red Flag 2: Failure to Report All Income
Let’s say, as just one example, you’ve received a 1099 form and you didn’t report that income. That discrepancy may very well trigger an audit of your tax return since the payer of the funds listed on the 1099 turns this document into the IRS. So, make sure you account for all your taxable income. (If you don’t include all your allowable deductions, that won’t trigger an audit, but it’s sure costly to you!)
Red Flag 3: Carefully Consider Work-Related Expenses
If work-related expenses cause your gross income to go down by a significant amount, the IRS might want to take a second look at them. So, before you deduct an expense, make sure it was necessary for your work. If you’re a professional golfer, then new clubs make sense on a tax return; if you’re a teacher, then school supplies do. But, if you are a nurse by trade and like to do yoga on the weekends, is the purchase of a new yoga mat really related to your job?
Red Flag 4: Errors on the Return
To quote NerdWallet.com, “When the IRS starts investigating, ‘oops’ isn’t going to cut it . . . Don’t accidentally write a 3 instead of an 8. Don’t get distracted and forget to include that final zero. Mistakes happen, but make sure you double- and triple-check your numbers if you’re doing your own taxes. You’ll be hit with fines regardless of whether your mistake was intentional.”
To help ensure your tax return is without error, use a professional tax preparer, and make your choice with care. Avoid businesses that pop up seasonally to take advantage of the large numbers of taxpayers needing help. At Key Tax Group, we see errors in approximately 95 percent of tax returns prepared by seasonal tax preparers.
Red Flag 5: Dicey Tax Deductions
Yes, you should assertively take advantage of all the deductions you are entitled to. That’s just smart money management. But, if you include unrealistic or unlikely deductions, this can flag your return for an audit—and, if you can’t support those deductions with an acceptable amount of documentation, that can signal trouble.
Red Flag 6: An Abundance of Charitable Donations
If you donate funds to charities, that’s admirable—and, when backed up by documentation, they’ve been tax deductible. If you can’t provide the documentation, though, don’t claim the donation. Then, for next year, create a plan to carefully keep track of all the money you do generously donate to charities.
Red Flag 7: You and Your Ex Don’t Agree
If you are paying or collecting alimony, then it’s important that what you report about the transactions matches what your ex-spouse did. And, if both of you claim child-related tax benefits (the dependency exemption, the child care tax credit, and the head of household filing status), that’s a problem.
What to Do if You’ve Been Selected to be Audited
Step one: do NOT ignore the letter. You may choose to represent yourself or acquire professional representation (more about that later!) but, no matter how you decide to proceed, you must respond. You need to collect relevant documents and provide them as necessary by the deadline, being polite and timely.
The Audit Process and What to Expect
First, if you ever receive a phone call saying your tax return was just chosen for an audit, that’s not the IRS. They do not initiate audits by phone. Audits are initially handled through the mail, and may continue through the mail system or through in-person interviews. According to Money.USNews.com, about 80 percent of IRS audits for individual taxpayers are correspondence-based.
Interview-based audits can take place at your home or workplace, at your accountant’s office, or at an IRS office. Interviews at your home/business or accountant’s office are called field audits, while those taking place at the IRS office is an office audit. Office audits tend to last four hours or less as the IRS focuses on limited issues. The field exam, then, is the type of audit that “strikes fear in the hearts of taxpayers . . . it involves ‘hours of intense review and verification by a revenue agent.’”
When you are initially contacted about the audit, you will receive instructions on what to do next as well as relevant contact information. The IRS will request information about certain aspects of your return, perhaps about your income, or expenses and/or itemized deductions. Here is a listing of the types of records the IRS might request.
If the information requested would be challenging to mail, you can request that the audit take place face-to-face. Auditors may use the most relevant Audit Techniques Guide to manage the process.
If an audit is not satisfactorily resolved (satisfactory to the IRS!), then they may extend the statute of limitations for assessment tax, which means that they can assess additional taxes.
Our Advice: Don’t Go It Alone
Here’s why you should get professional representation. First, the realization that you’ve being audited almost certainly feels overwhelming—and few people are at their best when they feel that way. Plus, audits are complicated and, without experienced representation, you could end up owing thousands of dollars to the IRS.
How much information should you disclose? What, specifically should you say? How should supporting documentation be presented in a way that will not cause an aggressive auditor to continue to delve into the situation? Once you’ve said or shared something, you can’t take it back, so it’s better to have expert guidance from the start. Something that starts out small and seemingly simple can open up a multi-year audit that wastes significant amounts of your time and money. In general, the IRS can review returns from the past three years in the auditing process although, if substantial errors are found, the IRS may continue to dig further into your tax return history.
Responding to audit questions can be a real balancing act, one where it’s crucial to be honest and to answer questions as completely as you can. But, you have to remember that you don’t need to offer up any information that’s outside the scope of what you’re being asked. Doing so “will only lead to new potential questions and possible expansion of the scope of the audit. You could also end up slowing the process if you throw every bit of information and data you have at your IRS agent.”
Here’s another problem. If the audit process doesn’t go well and you owe the IRS money that you don’t have, your credit may be affected if the IRS files a Notice of Federal Tax Lien on your property. Then you’ll need to work with the IRS to create a payment plan to get this tax lien off your credit report and your tax bill paid. If you find yourself in that situation, here is more information about the IRS Fresh Start Program.
If you need another reason why you should have professional guidance, the IRS could also “choose to assert a 20 percent accuracy-related penalty under Section 6662 if it deems even your mistakes on the return to be egregious or to represent a substantial understatement of your tax liability.”
Key Tax Group
Many professional firms don’t want to get involved in audit representation but, at Key Tax Group, we offer full-service representation throughout the tax auditing process. We understand that the process is complex and confusing, which is why we offer representation that starts even before you talk to tax authorities about your return.
We proactively review your tax return first, so we can pinpoint potential issues and be thoroughly prepared. This allows us to identify what supporting documentation can help your situation to minimize the impact of the audit and the associated assessments against you. If you ultimately are assessed a penalty, our tax professionals help you to set up a resolution based on your specific financial situation to pay off your IRS tax bill.
Let us help protect you! Contact Key Tax Group online or call (800) 380-7085 for your free initial consultation. And, looking ahead, the enormous tax overhaul bill from 2017 will change multiple aspects of what you can claim and deduct and so forth on your tax return, and we’re here to help you navigate that process, as well.