An IRS audit is a review or examination of a business’, organization’s, or individual’s accounts and financial information to determine whether the person has been reporting the required information correctly under the federal tax laws and to verify whether the amount that has been reported for tax purposes are accurate.
When the IRS selects a person or an organization to audit, it does not always mean that an error has been made or found. Sometimes, audits are selected using a variety of methods:
- Random selection through a computer screening based on a statistical formula
- Documents that the person has reported are not matching or is not accurate
- Taxpayer’s information that has been reported involves one or more issues and requires an examination or review to determine the error found
If you receive an audit letter from the IRS, do not panic. Here are some things you can do to prepare for an IRS audit:
- Examine your records to determine whether the IRS wants to audit the entire income tax return or merely a portion of it.
- If the issue involves documenting a tax deduction or credit, provide copies of the appropriate documents to the IRS. Make sure to keep the original documents.
- If the IRS wants documents that you no longer have, try to reconstruct them.
- Provide worksheets to the IRS that demonstrate how the tax figures in question were calculated.
- Consult a tax attorney or other advisor.
- If only a portion of the tax return is being audited, provide only the records relevant to that part. Do not volunteer information when it is not requested.
- Be organized, and arrange documents in categories of the tax items in question.
- If you are not sure exactly what the IRS is looking for, do not be afraid to ask questions to clarify the audit request.
A small number of individual tax returns are audited each year. Computer programs select which to audit by developing norms after reviewing millions of tax returns. If a tax return differs significantly from the norm, there is a greater chance that it will be audited.
The most common ways that a person will be red flagged for an audit or a personal return would come to the attention of the IRS include:
- Incomplete tax returns that have missing information and/or math errors
- Unreported income and/or failure to report taxable income that has been received
- Suspiciously low income that is a lot less than others in the same profession
- Suspiciously high income
- Drastic changes in income that are very different from the years before
- Too many charitable contributions with no reported receipts or proof of contribution
- Participation in tax scams
- Many high-itemized deductions that a person is not entitled to
- Disagreements between Federal and State returns
An audit red flag does not mean that the IRS would automatically audit a person. When a person’s tax returns is brought to the attention of the IRS, it means that the person’s information and reported returns will now be turned over to an actual human for examination and review. If the person determines that suspicious activity exists in the person’s tax returns, an audit will be scheduled.
Taxpayers have several rights during an audit examination, appeal, collection, and refund process. These rights include:
- A right to professional and fair treatment by the IRS
- A right to privacy and confidentiality about tax matters and information
- A right to know 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 after it has been requested to be examined
- A right to legal representation
- A right to appeal the decision both within the IRS and before the courts
If an audit error has been found, a conference will be set up and a manager will be assigned to the case for further review or the issue or issues. If the person disagrees with the audit findings, the person has the right to appeal and may take the case to an appeal mediation program or file an appeal request.
The IRS might drop the tax penalty if you can show that you made an honest mistake in preparing your tax return. If you have made a mistake, you should prepare a letter explaining the mistake.
You may be faced with different types of audits.
- In a field audit, an agent of the IRS actually comes to your workplace.
- In an office audit, you will have to provide information in person, in the IRS office.
- In a correspondence audit, you will be asked by mail for proof of deductions or other relevant information.
Tax law is very specialized and involves many different issues. To avoid spending too much time and money, it may be a good idea to consult a tax attorney to help you prepare for an audit.