People often imagine IRS auditors as scary, calculator-wielding mercenaries who are just out to get more money from you. Yes, an IRS audit can uncover some mistakes on your tax returns, and those mistakes could cost you money. Plus, dealing with an IRS audit is almost guaranteed to take up valuable time you’d rather spend doing, well, anything else. But in reality, you only have something to fear if you’ve intentionally falsified your taxes or are guilty of tax evasion fraud.
Nevertheless, there’s a chance the IRS could audit you during your lifetime — either as part of a randomly selected group or because you have certain red flags in your return. The IRS generally has up to three years after you file or the due date of your tax return (whichever is later) to audit your return, but it can audit up to six years later in some cases. If you file a fraudulent return or don’t file at all, there is no statute of limitations on when the IRS can audit you.
The good news is very few taxpayers have to deal with an IRS audit each year. According to statistics from the IRS, out of the 196 million tax returns filed in calendar year 2017, the IRS audited just 1 million returns. That’s only 0.05% of all returns filed.
But if you’re ever one of the unlucky few who face an IRS tax audit, there are a few things you need to know.
Types of Tax Audits
There are three basic types of IRS audits: correspondence audits, office audits, and field audits.
1. Correspondence Audit
A correspondence audit is the most common type of IRS audit. Out of the 1 million tax returns audited in 2017, more than two-thirds were correspondence audits.
A correspondence audit is essentially a letter from the IRS asking you to provide information and documentation to support the information on your tax return, including income, expenses, and tax deductions and credits.
The initial letter from the IRS is usually IRS Letter 566. In this letter, the IRS asks questions about specific items on your tax return and provides a deadline to receive your reply. If you don’t supply the requested information or reach out to the IRS with a request for more time, the IRS sends another letter explaining changes they’re proposing to your tax return.
One common issue that leads to a correspondence audit is when the IRS’s records don’t match up to what you reported on your return. For example, say you deducted mortgage interest as an itemized deduction, but the IRS didn’t receive a matching Form 1098 from your mortgage company. These issues are usually easy to solve by sending a copy of your form or writing a letter explaining the circumstances.
Other times, the IRS sends a letter stating you owe a late filing penalty because they received your tax return after April 15 (July 15 for 2019 returns) and you didn’t file an extension. If you can send them proof you sent your tax return via certified mail by the deadline, the IRS removes the penalty and closes your case.
Of course, sometimes people do make mistakes on their tax returns. If you made an honest mistake and the IRS determined that you owe additional taxes or penalties, you can choose to either pay the additional amount due or appeal it and move on to the next step of the audit process. If you don’t think you have a good chance of proving your case, and especially if the amount is small, you’re likely better off paying it. If you delay paying what you owe, the interest and penalties continue to grow. And if you can’t prove your case, you’re now on the hook for the additional tax plus all of the interest and underpayment penalties that accrued while you fought it.
2. Office Audit
An office audit involves a letter from the IRS asking you to compile documents from a list they provide you and then report to your local IRS office to go over them with an IRS examiner.
Frequently, the IRS uses these types of audits for small businesses or individuals whose tax returns have more serious issues.
The IRS tends to audit small-business tax returns more frequently than individuals since business returns are a popular way for people to write off personal expenses, pad deductions, employ relatives who don’t actually work, and other tax-avoidance schemes.
If you know you can back up the income, deductions, and credits on your return, gather the information requested in the letter and show up at the appointed time. In most cases, the IRS chooses the date and time of your meeting at random. If that appointment doesn’t work for you or if you need more time to gather the requested documentation, contact the auditor assigned to your audit to reschedule it for a better time.
3. Field Audit
A field audit involves an IRS revenue agent — and sometimes multiple agents — coming to your home or business to inspect your records and get a better understanding of how the business works.
A field audit is more common for businesses. But the IRS can also select individuals for a field audit, especially if they have reason to believe you’ve significantly underreported your income. Visiting you at your home or place of business gives the revenue agent a chance to compare your lifestyle to the amount of income you’ve been reporting on your tax returns. If you have an accountant (CPA) or tax attorney, you have the right to request that the field audit take place at the accountant or attorney’s office. In fact, even if you didn’t work with an accountant to prepare your tax return, it’s a good idea to hire one to represent you during a field audit. They usually have experience dealing with IRS agents and auditors, can help you answer questions, and can help you avoid making a stressful situation worse. This article from the Accounting Institute for Success covers CPAs’ capabilities and expertise in more detail.
Your initial notification of the field audit comes via mail, but the IRS revenue agent may call you to set up a date for the audit and discuss the types of records they want to look at.
Tax Audit Help & Tips
Understanding the audit types isn’t the only essential component of successfully managing an IRS audit. There are several other things you can do to swing the odds in your favor.
- Get Professional Help. If the IRS determines you made a mistake, you’ll likely owe extra taxes. However, if you discover further deductions or credits you’re entitled to, the IRS will cut you a check for what it owes you. Therefore, it’s vital you work alongside the agent and keep your eyes open for any mistakes or omissions. Furthermore, many online tax preparation software programs like TurboTax or H&R Block offer audit assistance. If you used one of these programs, see if you can get help through them.
- Stay Organized. Throughout the year, keep all your paperwork and receipts organized in appropriately labeled folders. The more organized you are during an IRS audit, the better chance you have of the examiner’s decision going your way. If possible, keep your records in a fireproof safe or save digital files on the cloud to ensure they’re not lost if you suffer a home fire or other disaster.
- Don’t Ignore IRS Notices. Whatever you do, don’t ignore correspondence from the IRS hoping it will go away. It won’t. Seek out professional help if you’re nervous about dealing with an IRS audit on your own. Hiring a pro costs money, but the peace of mind you get from letting them handle the examiner’s questions and requests for additional information is well worth it for many people.
- Appeal the Decision (if Necessary). Once the audit is over, the auditor will send you an examination report detailing their findings and outlining how much, if anything, the auditor believes you owe in back taxes and penalties. You can either agree with their conclusions and sign the examination report or dispute it by going through the IRS’s Fast Track Settlement program or filing an appeal. Your accountant or attorney can help you decide which method is right for you and guide you through the process.
- Act Professionally. Whether you work with a professional or go it alone, make an effort to stay on good terms with the auditor. While you absolutely should ask questions and stand up for legitimate deductions and tax return positions, keep in mind that auditors have the authority to dismiss or lower penalties if they choose. Be honest, reasonable, and professional with your auditor, and you should get the same treatment in return.
Being the subject of an IRS audit is stressful. However, if you’ve kept careful records and been honest with the IRS, you don’t have to worry about being accused of fraud or winding up in federal prison. Just cooperate, be prepared with your documentation, and everything will turn out fine.
Have you ever dealt with an IRS audit? Would you add any tips to this list?