The words “tax audit” can strike fear into the heart of even the most organized, always-on-time taxpayer. Whether it’s an IRS tax audit or state sales tax audit, few people know much about the process. While that process can be very complex, learning more about it can provide at least some peace of mind if you’re faced with an audit. Read on for information about what to expect from a tax audit, what you can do to prepare for it, and how the tax audit representation experts at Key Tax Group can help.
Reasons for being audited.
Some audits are triggered by something as simple as an error in your math; some are random; others arise from serious issues such as not being truthful about your total income. In between are many reasons you may have drawn the attention of the IRS, including:
- Choosing the wrong filing status: One spouse with the status of “married filing separately” and the other with “married filing jointly” may draw unwanted attention from the IRS. You and your spouse must use the same status, and both must either itemize deductions or claim the standard deduction.
- Excessive business expenses: Large dollar amounts in categories such as meals, entertainment, and travel may be closely scrutinized.
- Not reporting all of your income: The IRS receives forms from your employer and others who paid you; when the numbers you report don’t match up to the income others reported, expect to hear from the IRS.
- Errors or omitting information: Mistakes in math are easy to make, but they’re also easy for the IRS to spot. An audit may not ensue—you may simply be asked to pay any extra you owe—but errors and omissions do expose your return to the IRS’s scrutiny.
- Dependent claims: Only one parent is allowed to claim a child on his or her tax return. Be sure you don’t claim a dependent that your child’s other parent is claiming.
- Charitable donations: Large totals of charitable contribution deductions, particularly when your income level doesn’t appear to support them, may make you appear to be avoiding paying the full amount of taxes you should be paying.
- Cash transactions: Cash-based businesses or people who receive cash payments, such as waiters, can be targeted for audits since it’s easy to under-report cash income.
- Living abroad: Filing taxes from outside the U.S. requires the completion of an often-confusing set of forms.
Another category of reasons why a tax audit may be initiated are tax-related scams. These include fraud by tax return preparers, donating to fake charities, and more. Read the IRS’s summary of its “Dirty Dozen” list of tax scams for more information.
Types of IRS audits.
The image of a nervous taxpayer facing stern IRS examiners across a conference table often comes to mind, but there are different types of IRS tax audits:
Correspondence audit: As it implies, this audit is conducted via letter. You receive a notification from the IRS that includes a request for documentation or clarification about an issue. If you’re unable to provide the IRS with the documentation that supports your claim, penalties and/or interest may be assessed, so it’s advisable to get help from a qualified tax professional.
Field audit: Physically, this type of audit will be done at your home (or at your business if the audit is on your business taxes). In scope, however, a field audit is the most comprehensive type. The IRS may ask to review a very wide range of documents in a field audit, a potential indication of seeking some specific information.
Office audit: In this type of audit, you do to an IRS office where you will provide documentation that would have been requested in the IRS’s original notification to you.
Keep in mind that one type of audit is not necessarily more or less serious than another, since any audit may result in the assessment fines, penalties, and interest.
Your rights as a taxpayer.
Like all taxpayers, you have both rights and responsibilities. According to the Internal Revenue Service’s Taxpayer Bill of Rights, you have the right:
- To be informed: You’re entitled to clear explanations of laws, IRS procedures, and the IRS’s decisions about your tax accounts.
- To quality service: You have the right to receive courteous, prompt and professional assistance in your dealings with the IRS and to speak with a supervisor about poor service.
- To pay no more than the correct amount of tax: You have the right to have the IRS properly apply all of your tax payments and to pay only the amount of tax you legally owe, including interest and penalties.
- To challenge the IRS’s position and be heard: You have the right to raise objections and provide additional documentation in response to formal IRS actions.
- To appeal an IRS decision in an independent forum: You’re entitled to an impartial and fair appeal of most IRS decisions and generally have the right to take your case to court.
- To finality: You have the right to know exactly how much time you have to challenge the IRS’s position and the amount of time the IRS has to collect a tax debt or audit a particular tax year. You also have the right to be informed when the IRS has completed an audit.
- To privacy: An IRS inquiry, examination or enforcement action should be no more intrusive than necessary and must comply with the law.
- To confidentiality: Any information you share with the IRS should not be disclosed unless authorized by you or by law.
- To a fair and just tax system: You have the right to expect that the facts and circumstances that may affect your ability to pay or provide timely information or affect your liabilities are taken into consideration.
- To retain representation: If you cannot afford representation, you have the right to seek assistance from a Low Income Taxpayer Clinic. You also have the right to retain an authorized representative of your choice to represent you in your dealings with the IRS.
Each state also has their own Taxpayer’s Bill of Rights in its constitution that includes many of the same rights that are in the IRS’s bill and more.
What to expect in an IRS tax audit.
When you receive a notice that you are being audited, keep in mind that in most cases, the IRS is simply requesting clarification, answers to a few questions, or perhaps documentation to support the legitimacy of a deduction you’ve taken. This can, most often, be handled entirely via mail.
The notification of a tax audit will include the reason your tax return has been selected for an audit, as well as a deadline for your response and instructions that you should follow. Your audit will be conducted by mail or in an in-person interview at your home, business, or accountant’s office, or at an IRS office. The IRS states that in-person interviews are uncommon, and are usually conducted for businesses or individuals that are subject to a criminal activity or fraud and earned more than $100,000. Correspondence audits are handled by mail and will not result in an in-person meeting if you submit proper documents.
There are three possibilities for the outcome of your audit:
- Agreed: Your tax return is changed and you are charged additional taxes, penalties or interest. You can accept the changes and pay the new balance.
- No change: Your information is deemed accurate and the audit process ends with no changes to your tax return.
- Disagreed: The IRS concludes that your return is subject to additional taxes, penalties or interest, but you reject that conclusion. You will need to prepare a document to support your dispute and schedule an in-person meeting with the IRS. In this case, the assistance of a tax audit lawyer can help ensure that your rights are fully protected and that you reach an appropriate outcome.
Remember, not all communications from the IRS are notices of a tax return audit. According to the IRS’s web page on “Understanding Your IRS Notice or Letter,” notices or letters you receive will include the reason the IRS is contacting you and instructions on how to respond. Be sure to read it carefully: You don’t want to complicate what may be a simple matter by omitting information or submitting erroneous information.
The IRS sends written communications for any of several reasons, including:
- Questions about your tax returns
- The need to verify your identity
- You have a balance due
- The need for more information
- Notice of delays in processing your return
- You are due a smaller or larger refund
- The IRS changed your return
If you’re asked in the communication to respond by a certain date, it’s important that you do so in order to preserve your rights to an appeal if you disagree and to minimize penalty charges and additional interest. If you cannot pay the full amount you owe, the IRS advises you to pay as much as you can or apply for an Offer in Compromise. If you would like to know more about Offers in Compromise, get in touch with the tax professionals at Key Tax Group for a free initial consultation.
An important note: You will be notified of the audit by the IRS via mail. Mail is the only way the IRS will notify you: If you receive a phone call or email, it’s very likely that someone is attempting a scam. Phone scammers’ tactics are becoming increasingly sophisticated: They can even alter the caller ID information you see to make it appear that the IRS is calling. Be aware, however, that scammers may also use notices or letters that are mailed or faxed to you. The IRS offers information on how to report scams or what to do if you receive a suspicious IRS-related communication.
Tax audit document checklist.
Proper documentation is essential to successfully concluding the tax return audit process. The IRS will request copies of specific documents that prove the credits, deductions or income claimed on your return, which may include one or more of the following, depending upon whether you are being audited for your individual return or your business return:
▢ Calendars, logs, appointment books or other records of expenses or expense-related activities
▢ Bank records and statements, receipts for purchases, canceled checks, or written records for payments made in cash
▢ Credit card statements, including those in electronic form
▢ Invoices from organizations or people you paid
▢ Ledgers, if you keep them, or other records such as cash register tapes or checkbook registers
▢ Records for equipment that is cited in your tax return; this may include computers, vehicles, mobile phones, copiers, or other items used in the regular operation of your small business
▢ Records related to the use of your vehicle, such as repair receipts, gas receipts, and mileage logs
▢ Records of rental expenses for your business
▢ Travel and entertainment records, such as an appointment book
▢ Loan agreements
▢ Medical records
▢ Theft or loss documents, such as insurance reports or an adjustor’s appraisal
▢ Charitable contribution records
▢ Legal papers, such as divorce settlements or property acquisitions
▢ Employment documents, such as continuing education requirements
▢ Schedule K-1 reports of shareholders’ share of income, losses, credits, and deductions
Tax audit FAQ
Q: Why am I being audited?
A: According to the IRS, simply being selected for an audit does not necessarily mean you’ve done anything wrong. The IRS has several methods by which it selects taxpayers for an audit, including random selection and computer screening, which it says is based solely on a statistical formula that compares your return against accepted norms for returns similar to yours. Your return may also be selected if it involves other taxpayers whose returns are being audited.
Q: What will the IRS tax auditor or examiner look for?
A: Errors are expected and minor ones will not usually be a problem when the examiner encounters them. What he or she is really looking for are red flags such as these:
- Inconsistencies in your bank deposits compared to the income you reported on your tax return
- Hidden property, brokerage accounts, or bank accounts
- Personal expenditures that appear excessive for the amount of income you reported
- Income from business sales that were deposited directly into personal accounts
- An excessive overstatement of deductions
Q: How will the IRS auditor know how much income I had in any given year?
A: The IRS examiner will look at a number of records to determine your income, and use them in comparing the income you reported on your tax return. These records include:
- Your 1099 form if you were an independent contractor
- Your W2 if you were a salaried employee
- Forms sent to the IRS that reported mortgage interest you paid, interest income you received, funds received from the sale of bonds or stocks, and more
Q: How many years’ worth of returns with the IRS include in an audit?
A: According to the IRS’s website information regarding small business audits, it generally includes the last three years of filed returns and usually does not go back more than six years. As with all aspects of tax audits, there are exceptions—consult an experienced tax attorney for guidance.
Q: What if I need more time to respond to the letter the IRS sent?
A: The IRS may grant you a one-time, automatic 30-day extension for audits conducted by mail. You will need to fax or mail the IRS a written request for this extension. You’ll be notified if the IRS can’t grant your request. There are other factors involved in extending the deadline, so it’s advisable to consult with a qualified tax audit professional for guidance.
In-person audits require you to contact the auditor assigned to you to ask for an extension.
Q: I disagree with the findings of the audit. What do I do next?
A: As stated above in the Taxpayers Bill of Rights, you have options when you wish to dispute the auditor’s findings, including asking for a meeting with an IRS manager. You may also be able to file an appeal or take advantage of one of the IRS’s mediation programs. Keep in mind, however, that unless you are well-versed in tax matters, your best course of action may be to have a tax lawyer represent you.
Q: What is tax audit representation?
A: You have the right to have an authorized representative to stand in on your behalf during an audit. Also known as audit defense, tax audit representation is the service that provides this representative, who is required to have certain credentials and permission to practice before the IRS. Your tax audit representative can be expected to help you prepare the documentation requested by the IRS, take care of correspondence on your behalf, and attend all in-person meetings with IRS auditors or examiners.
If the IRS simply wants a few receipts or a missing form (and is dealing with you via mail), you may be able to settle the matter on your own by satisfying the request. If, however, you are facing an in-person field audit or office audit, you should retain the services of a tax professional. While you may believe that the presence of a tax attorney might antagonize the examiner or may your situation worse, the opposite is usually true: The auditor will be dealing with a tax professional who will very likely make the entire audit process go much more smoothly and efficiently.
Note that there are different types of tax professionals with different qualifications and credentials. The IRS notes that an important difference in the types of practitioners is representation rights, which are either unlimited or limited. Those with unlimited representation rights “may represent their clients on any matters, including audits, payment/collection issues, and appeals,” according to the agency’s web page on “Understanding Tax Return Preparer Credentials and Qualifications.” These practitioners included attorneys, certified public accountants, and enrolled agents who are licensed by the IRS. Conversely, those with limited representation rights “cannot represent clients whose returns they did not prepare and they cannot represent clients regarding appeals or collection issues even if they did prepare the return in question.” This important difference between practitioners is why it’s critical to work with a qualified tax attorney, such as the team at Key Tax Group.
Tips for avoiding an IRS tax audit.
The best way to stay off of the IRS’s audit radar is to take a few simple steps throughout the year and at tax filing time:
Prepare your return carefully: When preparing your tax return, take your time. Review all of the information on the forms you complete and all attachments. Make sure you’ve correctly listed your Social Security Number, address and even your name, and have actually signed your return. See that you have proof of all claims and deductions. And when it comes to the math, make sure it’s accurate down to the penny.
File on time: Not only can this help you avoid being audited; it will also help you avoid penalties.
Don’t omit any income: With the potential to trigger an audit, omitting even very small amounts of income is not worth the risk.
Watch expenses: As noted above, travel and entertainment expenses may be red flags, and home office deductions may draw attention as well. Either avoid listing excessive business expenses or make sure you have detailed documentation to back them up.
Keep good records: Review the information in the sections above to know what may trigger an audit, then make sure to keep the types of records and receipts the IRS requires for proper documentation.
How a tax professional can help.
It’s a given that tax matters and the tax code are complex, which is why having experienced IRS tax audit help on your side can make the difference between making things even more complicated or being able to take advantage of every legal deduction. At Key Tax Group, we offer full-service IRS tax audit representation and will work diligently to protect your interests.
If you are facing an audit or need assistance with other tax debt problems, don’t hesitate to get in touch to schedule your free, no-obligation initial consultation. We’re here to help.