Many people find the idea of an IRS audit quite intimidating, especially if you’ve taken care to file your taxes on time and correctly. The good news is that the risk of this happening is low for the average taxpayer.
Nonetheless, it’s important to be aware of what an IRS audit is, how it’s conducted and the circumstances in which you may need to be prepared for one.
What is an audit?
An audit is an examination conducted by the IRS to ensure that the financial information and tax amount reported by an individual or organization are accurate and correct according to the tax laws.
The IRS conducts audits to ensure that the “tax gap” (the difference between taxes owed to the IRS versus what is actually received) is kept to a minimum. Some people are audited at random, but other times, taxpayers are chosen because their tax filings raise suspicion. This may happen due to unreported income, overclaimed expenses or math mistakes, especially when self-reporting.
People may also be audited in related tax filing examinations. In these cases, your returns may involve issues or interactions with other taxpayers (like business partners or investors) whose returns are being audited. Related examinations may also involve cases of information duplication, such as when two people claim the same dependents.
Depending on the issue detected, you can be audited at any point within three years of filing your return.
The audit process
Although audits by mail are more common, the IRS also conducts audits via face-to-face interviews. Interviews may take place in an IRS office (an office audit). Or you may be asked to meet with an IRS officer in an accountant’s office, your place of business or your home (called a field audit).
Either way, you’ll receive an audit letter with specific instructions and contact information relevant to your case beforehand. This will include the items on your return under review, a list of documentation you’ll need to provide and the deadline for submitting that.
In most cases, you’ll need physical copies of the documents to send by mail or be reviewed in person. In some cases, the IRS accepts electronic records produced by certified tax softwares. These may replace and/or be in addition to other records, so check with your auditor to understand what may or may not be accepted.
Remember that you’re legally obligated to keep any records used in your tax returns for at least three years after filing them. It’s wise to create an accounting system for organizing and accessing them if ever you need to.
The most common IRS audit causes
IRS audits can be requested for a number of reasons ranging from minor to more complex, and whether the fault was intentional or not. Each case is unique, but below are some of the most common reasons why the IRS may start an audit investigation:
- Unreported income. One way to land an audit is by not reporting some of your income. One common scenario where this may happen is if you’re an employee of one company and freelance on the side. It may be tempting to only submit the W-2 from your employer and leave off the 1099 form, but the IRS is likely to find out sooner or later since the recipient of your freelance work will submit a copy of the 1099 for their return.
- Math mistakes. “Oops” doesn’t cut it. Even if you accidentally turned that 8 into a 3 or you miscalculated a figure, you’ll be fined for incorrect math on your return. This is true for all taxpayers. Especially if you’re filing on your own or feel shaky about your numbers, double- and triple-check your return before sending it. You can also use a tax preparer or preparation software to ensure that everything adds up.
- Too many business expenses. Specifically for people who are self-employed, you may think of claiming personal expenses as business expenses. However, eligibility for this deduction means that the expense needs to be both ordinary and necessary to your business. If your purchase in question is neither common, accepted nor helpful to your line of work, it probably isn’t one to write off on your return.
- False charitable deduction claims. It’s one thing to make significant contributions to charity and then claim some well-deserved deductions. However, it’s another thing to claim you’ve donated when you haven’t. If you don’t have the documents to prove a contribution, don’t report it.
- Neat, round numbers. It’s highly unlikely that the numbers on both your tax return and its supporting documents will end cleanly with a 0 every time. As much as possible, be precise in your calculations, avoid estimations and round to the nearest dollar, not the nearest 100. For example, if you have an expense that is $587.35, round to $587, not $600.
This isn’t a complete list of why the IRS may request more information from you. That’s why it’s a good idea to contact your auditor for details on your specific case.
What to do if you receive an IRS audit letter
To avoid any penalties or fees, respond to an IRS audit letter within 30 days with either a phone call or an audit response letter.
No matter your situation, even if the thought of audits or high unpaid tax balances seems daunting or scary, it’s in your best interests to communicate with the relevant contacts to understand your options and keep the process as smooth as possible. Remember that, even if things don’t go the way you hope, in most cases you have certain rights and several options.
The first thing you should do after receiving an audit letter is gather all the documents that you’re asked to present. You’ll get precise instructions about what you need, but such proof may include receipts, appraisals, canceled checks and mileage logs. (It’s good practice to keep this documentation well organized and in your records for at least three years.)
Writing a response letter to the IRS
After you’ve collected all your documentation, write a complete audit response letter that addresses each item under review, provides all supporting documentation and requests a time and date to meet and resolve the issues. A compliant audit response letter also includes:
- Full name
- Tax ID number
- Contact information
- Employee ID
- Business ID (if applicable)
- The name of the IRS officer in charge of your case
There is some risk involved if you choose to write this letter without the help of a certified tax professional. Your audit response letter must be completely compliant with the IRS’s specifications—even one mistake could result in a delay of your case or other penalties. On the other hand, a correctly written letter can significantly expedite a resolution.
How long does an audit take?
The amount of time it takes to complete an audit varies.
Factors such as the type of audit, availability of requested information, complexity of the issues, availability of all parties for the purpose of scheduling meetings and your agreement or disagreement with the findings all play a role in determining how long your audit may take.
As a general estimate, if you respond on time in a single, clear letter that explains the situation and provides any necessary documentation, you may be able to complete a mail audit process in about three months. If you don’t, you may be looking at a process that could take a year or longer.
What happens after an audit?
Once the audit is complete, you’ll receive an IRS General 30-Day Letter as well as a form that describes the auditor’s findings. Depending on whether or not you agree with the findings, you can either sign an agreement and pay any balance owed (if at all), or file an appeal.
If the IRS finds that no change is required, this means that all items and forms have been reviewed and approved by the IRS and no further changes are needed on your original tax return.
If the IRS finds that changes are required to your original tax returns, you have two options:
- Agree with the changes required
- Disagree with the changes required
If you agree with the IRS
If you agree, you need to sign either the examination report, an agreement form (known as Request for Consideration of Additional Findings) or other similar documents that you may receive with the auditor’s conclusions and proposed changes.
If you owe further taxes, which may not necessarily be from the current tax year, you’ll receive a Notice of Deficiency, or a 90-Day Letter. You’ll have 90 days from receiving this notice to pay the amount or file a petition with the tax court.
Treat this letter seriously. Not responding promptly can limit or eliminate the options you have to address the balance.
If you disagree with the IRS
If you disagree, you have several options. You can request a meeting with an IRS manager, file a tax appeal (if there’s enough time left on the statute of limitations) or lodge a protest with the tax office.
The IRS also offers mediation through a relatively new program called Fast Track Settlement. This process allows the taxpayer and IRS to settle the dispute in an expedited and theoretically less complex way. You can still appeal later if you’re unable to reach a settlement here.
Get help with a tax audit
If you have any doubts about your general audit process, writing your response letter or your options for appeal, meet with an experienced tax attorney. They can provide more information, answer your questions, communicate with the IRS and ensure you’ve done all you can for the best possible outcome.
Make sure to bring these items to your appointment:
- A copy of your IRS audit letter, including any Information Document Requests (forms 4564, which are attached to the letter)
- Any information and documents the IRS is requesting
- A copy of the tax return in question
- Copies of your returns from the two years before the return in question
- A copy of the most recent year’s return (if it’s not the return being audited)
- A copy of any documentation you provided to your tax preparer
- Any documents that show the results of any prior audits
- A copy of any other IRS letters or notices that you’ve received for the tax year in question
Sofie is a writer. She lives in Brooklyn.
