The Internal Revenue Service (“IRS”) is the federal agency that collects American’s taxes. The IRS is also responsible for enforcing tax laws, which govern the taxation process. Some examples of what the IRS handles include:
- Collecting individual taxes;
- Collecting employment taxes;
- Corporate, gift, excise, and estate taxes; and
- Mutual funds and dividends.
An audit by the IRS is a review or examination of a business’, organization’s, or individual’s accounts and financial information. This is conducted by the IRS in order to determine whether the audit’s recipient has been reporting the required information correctly under the federal tax laws. Audits are also used to verify whether the amount that has been reported for tax purposes is accurate.
There are many ways in which the IRS selects which returns are to be audited. An example of one of these methods would be random selection by way of computer screening, in which a statistical formula is used as the basis of selection. Another example would be how the IRS may try to match one tax document to another tax document. If records such as Forms W-2 and Forms 1099 are inconsistent with the information reported, that reason could constitute an audit.
Additionally, the IRS could decide to audit a tax return if it involves issues or transactions with other taxpayers whose returns were chosen to be audited. Examples of other such taxpayers include business partners and investors.
It is important to note that when the IRS selects a person or an organization to audit, it does not necessarily mean that an error has been made or found.
What Are My Chances of Being Audited?
Each year, there is a relatively small number of individual tax returns that are audited. As previously mentioned, computer programs may be used to determine which returns should be audited. These programs select which returns to audit by developing norms after millions of returns have been reviewed. If a tax return differs significantly from the established norm, there is a greater chance that that return will be audited.
Some examples of the most common reasons why a return will be red flagged for an audit, or that a personal return would come to the attention of the IRS, include but may not be limited to:
- Incomplete tax returns, such as returns that have missing information and/or mathematical errors;
- Unreported income;
- Failure to report taxable income that has been received;
- Suspiciously low income, such as income is a lot less than others in the same profession;
- Suspiciously high income;
- Drastic changes in income, such as changes that are very different from the reported income in years past;
- Too many charitable contributions, such as those with no reported receipts or proof of contribution;
- Participation in tax scams;
- Many high-itemized deductions that a person is not entitled to deduct; and/or
- Disagreements between Federal and State returns.
Something worth noting is that an audit red flag does not necessarily mean that the IRS would automatically audit a person. When a tax return is brought to the attention of the IRS, the taxpayer’s information and reported returns are to be turned over to an actual human for examination and review.
This would be in opposition to simply accepting the results of a computerized scan. If the person conducting the review determines that suspicious activity does exist in the person’s tax returns, an audit will be scheduled.
What Should I Do If I Am Being Audited By the IRS?
IRS audits can take place through mail, or through a face-to-fact interview and analysis of the taxpayer’s records. Such an interview could occur at any of the following locations:
- A local IRS office;
- The taxpayer’s home or place of business; or
- An accountant’s office.
If you are being audited by the IRS, they will inform you as to which records you will need to produce for review. You may be required to amend your return as a result of the audit. Additionally, it is possible that you may not be required to make any changes to your return.
Should your account be chosen for an audit, the IRS will inform you by mail or telephone. If you are notified by telephone, the IRS will also mail a letter of confirmation concerning the audit. It is imperative to note that the IRS does not use email notification for any of its processes. As such, if you receive an email stating that you are being audited, you should not take any action or provide any information to the person who emailed you.
If you receive an audit letter from the IRS, try not to panic. Again, not every audit necessarily means that something is wrong. Here are some things you can do in order to prepare yourself for an IRS audit:
- Examine your records in order to determine whether the IRS wants to audit the entirety of your income tax return, or just a portion of it;
- If the issue involves documenting a specific tax deduction or credit, provide copies of the appropriate documents to the IRS while ensuring you keep the original documents;
- If the IRS is requesting documents that you no longer possess, do your best to try to reconstruct them;
- Provide worksheets to the IRS which demonstrate how the tax figures being questioned were calculated;
- Consult a tax attorney or other advisor for peace of mind and assistance throughout the process;
- Be organized by arranging documents in categories of the tax items in question; and
- If you are not sure as to what exactly the IRS is looking for, do not be afraid to ask questions in order to clarify the audit request.
Do I Have Any Rights During an IRS Audit? How Might an Audit Conclude?
As a taxpayer, you have several rights throughout the auditing process. This includes during an audit examination, appeal, collection, and refund process. Some examples of these rights include:
- A right to professional and fair treatment by the IRS;
- A right to privacy and confidentiality regarding tax matters and information;
- A right to be informed as to why they are being audited, and why the IRS is asking for specific information;
- A right to know how the IRS will use their tax information once they have been obtained in order to be examined;
- A right to legal representation as needed; and
- A right to appeal the decision, both within the IRS and before the courts.
In the event that an audit error has been found, a conference will be scheduled and a manager will be assigned to the case. The manager is to further review the issues. If the taxpayer disagrees with the audit findings, they have the right to appeal the decision. They may also take the case to an appeal mediation program, or file an appeal request.
The IRS could drop the tax penalty if the taxpayer can prove that they made an honest mistake in preparing their return. If you believe that you have made a mistake, you should prepare a letter which explains the mistake.
There are three ways in which an audit may be concluded:
- No change, meaning you have corroborated all of the documents being reviewed so there are no changes to be made;
- Your agreement with the proposed changes by the IRS; or
- Your disagreement with proposed changes by the IRS.
If you agree with the audit findings, you will be asked to sign an examination report, or some other comparable form. If you do not agree with the audit findings, you may request a conference with a manager in order to further review the issues. You may also file an appeal.
Do I Need an Attorney If I Am Audited?
If you need tax help or are facing an IRS audit, you should consult with an experienced and local tax attorney. An experienced tax attorney can help you prepare all necessary documentation for the audit, and guide you through the audit process. Additionally, your attorney can also represent you in court as needed.