IRS audits are one of the most stressful events you can go through as a taxpayer, even if you haven’t done anything wrong. According to a recent survey, 32 percent of Americans would prefer to break their own arm, 13 percent would gladly spend a night in jail, and 6 percent would sell a kidney rather than doing their taxes. You have to wonder what they would do to avoid a tax audit! Although IRS audits are never fun, they don’t have to be a traumatic experience.
If an IRS Notice of Audit and Examination is making your life miserable, relax. Be smart. Instead of panicking, prepare yourself by reading this IRS tax audit survival guide from beginning to end. By the time you finish, you will know what to expect from an audit , how to stand up to the IRS and where to get help from. You will even learn a few tricks on how to avoid getting audited by the IRS in the future.
Why did the IRS Audit me? IRS Audit Triggers
In 2015, only 0.7 percent of returns were audited (Source). If you just received an examination notice (IRS jargon for audit), you are probably asking yourself “Why me?” More than likely, a computer is to blame.
The IRS uses a computer program called The Discriminant Function System to score tax returns based on IRS experience with similar returns in the past. Taxpayers are also selected for an audit as part of a random sample and document matching. Document matching is when documents provided by your employers or clients (W2s and 1099s) are matched to your tax return to check you reported them.
A tax audit does not mean you have made a mistake or tried to cheat on your taxes. In some cases, IRS audits result in refunds to the taxpayer or in acceptance of the original return without changes. This is particularly the case when taxpayers hire tax professionals to represent them. For instance, in 2015, 40,000 tax audits resulted in additional refunds totaling $1.1 billion (Source – IRS) Of course, that doesn’t mean you should not do everything you can to avoid one in the first place. And there are things you can do to reduce your chances of an IRS audit. (Read this article on 15 Flags The IRS Uses To Profile Taxpayers).
In a nutshell the IRS targets people who:
|Make a lot of money||If your annual income is more than $200,000, you have a 1 in 38 chance of being audited. Make more than $1 million? Congratulations but you may want to keep your accountant on speed dial. There is a 1 in 10 chance the IRS will audit your return.|
|Income discrepancies||The IRS checks the income employers and customers claim to have paid (1099s and W2s) and what taxpayers report.|
|Aggressive deductions||If you claim more deductions than the average for people in your income and business type, prepare to be audited. No big deal. Just make sure you can justify those deductions..|
|Business Owners and Self-Employed Workers||Being your own boss has many advantages. Being three times as likely to get audited is not one of them.|
|Take large charitable deductions||The IRS knows what the average person in your income bracket donates to charity. If you stand out, the IRS will check your numbers. By all means, be generous. Just make sure you keep your receipts.|
|Claim rental losses||The tax code gives generous deductions for rental losses, but the IRS does make a point to check the legitimacy of large rental loss deductions.|
|Write off a loss for a hobby||It’s okay to enjoy your job, but you better be able to prove your business has at least the expectation of making money. The rule-of-thumb is you make money at least three out of every five years.|
|Fail to report a foreign bank account||If you have forgotten to claim a foreign bank account, the IRS is currently offering amnesty to people who come clean.|
|Claim they use a vehicle 100% for business use||Unless you are claiming a deduction on a tractor, it is unlikely the vehicle is only for business use. This is an easy win for an IRS auditor.|
|Take an early payout from their retirement fund||Withdrawals from a retirement fund before age 59 and ½ can trigger a 10% penalty. The IRS likes to check you haven’t forgotten to declare retirement payouts.|
The best way to avoid an audit or to be prepared to deal with one is to hire a certified tax professional to prepare your taxes. This is particularly important if you are filing late returns.
What does an IRS Audit process look like?
If you are being audited, it is crucial you understand how the process works and what tax relief options you have available.
- Audit notification – If the IRS chooses your tax return for audit, they will notify you by mail or phone.
- Audit appointment – The IRS may ask to carry out the interview at your place of work, at an IRS office, or by mail
- Documents required – The IRS will notify you in writing what records they require. Auditors commonly use an Information Document Request, or IDR, to formally request documentation. You must retain your tax records for three years after filing your taxes.
- Audit outcome – An IRS audit may result in no changes, changes with which you agree, or changes with which you don’t agree. The auditor will explain any proposed changes to you.
Warning: Only provide documents that are directly related to the tax years audited. Just because the IRS requests documents through an IDR doesn’t mean you are required to provide them. If the auditor is fishing for information from years not included in the audit, ask why this is relevant. If the IRS requests items in the IDR that could incriminate you, you are in your right to not furnish them and wait to see if the auditor pursues it. The auditor will either let it go, not notice, or issue a summons.
IRS Summons – A summons is a legally enforceable order that you should not ignore. However, if the summons orders you to present documents that could incriminate you, is vague or unduly burdensome, or breaks attorney-client privilege they may be able to raise legal objections to the summons. Consult with a tax relief professional before replying to the IRS.
If you agree with the audit findings, the IRS will have you sign the examination report or similar form depending on the audit conducted. If you owe taxes, you will then need to choose the payment option that works best for your situation. If you disagree with the findings, you may request a meeting with a manager for further review of your situation. In addition, you may request an appeal.
IRS Audit Tip: You may audio record your audit interview. Make your request in writing at least 10 days in advance of your appointment and supply your own recording equipment. The IRS also can record an interview. If the IRS chooses to record it, they will notify you at least 10 days in advance of your audit. You may have a copy of the recording at your own expense.
What are different types of IRS Audits?
The IRS makes the final determination of what audit method to use. There are three types of IRS audits:
- Correspondence audit – For less complicated audits where it can be done by mail. This is the IRS favorite method. In 2015, 73 percent of audits were done via correspondence.
- Office audit – You’ll need to take your receipts and other documents related to specific questions about your return to a local IRS office.
- Field audit – An IRS agent comes to your home or place of business.
How long do IRS Audits last?
The length of IRS audits depends on the type of audit and the issues involved.
Correspondence Audits: On average, audits conducted via correspondence take two to four months to finish.
IRS Office Audits: The initial appointment for IRS office audits takes two to four hours, but additional appointments may be required.
Field Audits: The initial appointment of a field audit generally takes one to a few days to complete but some cases require additional appoints.
Regardless of the type of audit, you have the right to retain a tax attorney to represent you when dealing with the IRS. Only tax professionals authorized to practice before the IRS qualify. These include an attorney, a certified public accountant (CPA), an enrolled agent, or an un-enrolled Tax preparer who prepared your taxes.
Taxpayers who hire a tax professional to represent them can file a Power of Attorney and Declaration of Representative (IRS Form 2848). Only consider tax relief companies that employ tax attorneys, CPAs, and enrolled agents.
What should you do when audited by the IRS?
As mentioned above, being selected for an IRS audit does not necessarily mean you are in trouble or did anything wrong. For instance, in 2015, 9% of field audits and 12% of correspondence audits were won by the taxpayer with no changes to tax liability.
It is still important to act quickly and find out what the problem is. Acting promptly will help you avoid or minimize hefty penalties and interest. The IRS will try to schedule an appointment within two weeks. If you ask to postpone the appointment for more than 45 days, the IRS collector will need to ask a supervisor for approval.
- The name, identification number, and telephone number of your person of contact in the IRS is on the top right corner of the notice.
- Call or have your tax representative call the person handling your case.
If you have a good idea what the problem is and you know it will involve a large tax debt or charges of tax evasion, contact a tax professional as soon as possible. Time is of the essence when dealing with the IRS. The IRS doesn’t play games when it comes to tax fraud and has a conviction rate of over 80%.
On the other hand, if you are dealing with a simple, low-risk audit, such as a request for receipts to justify large deductions or a small tax debt due to a math error, you may be fine dealing directly with the IRS yourself. Just remember you have the right to interrupt an audit at any moment and say you want to consult with your tax professional before continuing with the audit.
- Once you arrange an appointment, your handler will send a confirmation letter with the date, time, and location you agreed.
- You will also receive an Information Document Request Form 4564 detailing the records the auditor wants to review. Remember that just because and IDR Form 4564 requires a document doesn’t mean you should provide it. Consult with a tax professional before furnishing documents or information that could incriminate you.
Never send or leave an original copy to a document. If a document gets lost in a sea of paperwork at your auditor´s office or it gets lost in the mail, it will be your word against the IRS. Guess who will win. During an audit, the burden of proof is on you, the taxpayer, and you need those documents to prove your claims.
- Carefully review the tax return under audit. If you used a professional tax preparer, review it with her. If you did it yourself, hire a tax professional to go over the return to see if she can spot what may have triggered the audit.
- Organize your personal and business records in preparation for the audit. Find all the receipts and documents you sued to file the return. You are required to keep records for three years from the date you file the relevant tax return. Business assets are an exception. Keep receipts on business assets for as long as you claim depreciation on them. First impressions are important in audits. Hiring a tax professional to put your records in order before the first appointment with an auditor can help set the tone you want for the rest of the audit.
- Research the relevant Audit Technique Guide (ATG) for your industry. The IRS publishes detailed guides for its agents to help them audit certain businesses, such as estate agents, attorneys, child care providers, hair salons, and car wash centers. ATGs are publicly available on the IRS website and provide useful information such as what questions you are likely to be asked and what income estimation methods agents will use for your industry.
Remember you can interrupt an audit at any moment and ask for time to consult with a tax professional. If an audit is not going well or you are concerned you may reveal information that will incriminate you, calmly stop the audit and ask for time to hire a tax representative.
Understanding an IRS Audit Letter
Here’s an IRS Audit Letter Sample (PDF)
IRS audit letters provide taxpayers with information and instructions on how to proceed with the examination. Make a copy of the audit letter and send it to your tax professional. Keep the original in your records for safekeeping.
On the top right, you will find the name of your contact in the IRS, his or her contact identification number and telephone number, and the office hours. On the top left is the address of the IRS office handling your case.
The body of the letter specifies the purpose of the audit and what documents the auditor requires to complete the examination. For instance, in this example, the IRS is requesting documentation that proves Antonio and Milagros Sanchez were entitled to claim an “unreimbursed employee expense.”
Unreimbursed employee expenses can include a wide variety of expenses, such as business travel away from home, business use of a personal car, business meal and entertainment, travel, use of home for business, tools, education, and supplies. Antonio and Milagros will need to find receipts, logs, work orders, and other documentation that supports their deduction.
At the bottom of the letter, the IRS specifies how much time the taxpayer has to provide the requested information. In this case, 30 days.
How should you act during an IRS Audit?
The IRS trains its auditors to pay special attention to the initial interview to assess the overall financial picture of your financial situation and that of your business. Be polite, calm, and confident. Remember, you are as much under examination as your return.
Never lie to or try to mislead an IRS agent. Auditors like to ask questions for which they already know the answers to see assess your reliability. If there is a question you don´t want to answer, it is preferable to say you don´t remember or that you will have to check. Keep your answers short and precise. Yes and No are great answers during an audit. Agents will often create silence or review your documents without saying a word hoping that nerves will get the better of you and you run your mouth. Don´t talk more than you strictly have to.
You can also buy time and deflect questions by answering with a question, such as “what specific documents or records do you want to see?” or “why do you want that document?” It is your right to know why information is required and how it relates to the audit. Other appropriate replies to difficult questions are “I will have to check,” or “I need to consult with my tax professional.”
If you haven’t already, seriously consider hiring a tax relief company. Take a tax attorney as your representative to an audit, particularly when the stakes are high and you owe more than a few $100’s. An experienced tax attorney or CPA will know what questions to answer freely and when to stonewall an auditor who is on a fishing expedition.
How far back can the IRS audit?
The IRS does not audit tax returns that go back further than six years. Typically, however, the IRS does not audit tax returns that are older than three years. The general rule is the IRS only has three years after you file to audit. The vast majority of tax returns audited are for returns filed in the last two years. However, if you omit 25 percent or more of your income or the IRS suspects tax evasion, the statute of limitations is extended to six years.
In some cases, the IRS requests taxpayers to voluntarily extend the statute of limitations to give it more time to audit an account. You can deny the request, but the IRS may just base its audit on the current information it has, which usually is bad news for taxpayers. Consult with a tax attorney before agreeing to an extension of the statute of limitations. Although agreeing to an extension is often the best move, there are times when it is smart to wait out a statute of limitations.
What are the chances of being audited by the IRS?
The odds of your tax return will be audited vary widely depending on your income, whether or not you own a small business, what deductions you claim, and even where you live.
The good news is that for the vast majority of taxpayers the chances of being audited are slim. In fact, in 2015, 99.2% of personal returns were not audited. That means the average taxpayer only has a 1 in 119 chance of being on the business end of an audit.
If you are not self-employed and don’t own a small business your odds are even better. In 2015, only 0.3 percent of personal returns without a Schedule C were audited. The less you earn the lower your chances. For instance, based on IRS data for 2015, a taxpayer who didn’t file a Schedule C (not self-employed) and made $60,000 a year would have a 1 in 189 chance of getting audited. The same taxpayer with a $250,000 income has a 1 in 65 chance of receiving and audit notice. However, a self-employed worker that made only $60,000 in 2015 would have a 1 in 42 chance of being audited.
Where to send IRS audit reconsideration?
Once an audit is completed, the IRS will send you a report with the results of the examination. If you disagree with the tax the IRS says you owe, you may have the right to request an audit reconsideration.
The first step is to carefully review the report and the attachments from the audit. Determine what items in the report you think are incorrect. Hire a tax professional to assist you.
Collect any documents that can support your case. Check the evidence you want to send was not part of the original audit and that it applies for the tax year that was audited.
Send a letter to the address on your audit notice. The letter doesn’t have to be anything fancy. Simply explain you want the IRS to reconsider the audit. Specify what changes you want the IRS to make. Attach a copy of the examination report (Form 4549) and copies of the documents that prove your claims. Remember NOT to send originals.
Consult with a tax relief company before sending an audit reconsideration application. There are circumstances when you don’t have the right to file for a reconsideration. For example, if you already agreed to pay the tax balance by signing a Form 906, Closing Agreement, and Offer in Compromise or an agreement with the Office of Appeals, you already forfeited your right to an audit reconsideration.
Are there any IRS Audit penalties? What are they?
An increase in your taxable income is not the only thing you have to worry about during an IRS audit. Auditors can also hand out penalties to taxpayers that don’t follow IRS regulations.
This is a list of the main penalties you can receive as a result of an IRS audit:
Deposit Penalty: If you fail to make a deposit on time the IRS can fine you 2% to 15% of the amount depending on how late you are.
Filing Late: Taxpayers who file late can receive a penalty of 5% the tax due. The penalty is charged every month the return is not filed up to five months.
Paying Late: Taxpayers who are late paying their taxes can be charged 0.5% of the unpaid tax every month up to a maximum of 25%.
Incomplete Return: Taxpayers can be charged $20 a day up to a maximum of $10,000, if your income is below $1 million a year, $50,000 if your income is over $1 million.
Penalty on Tips: Taxpayers who don’t report their tips on a return could be fined 50% of the social security tax on the unreported tips.
Frivolous Tax Return: Want to try your luck at invoking the First Amendment as an argument for not paying taxes? Think only foreign-source income is taxable? Prepare yourself for a $5,000 frivolous tax return penalty.
Misstating the Value of Property: If you overvalue donated property by 200% or more, you may have to pay a 20% penalty. Did you go crazy and overvalue the property by 400%? It may result in a 40% penalty.
Civil Fraud Penalty: If an audit uncovers evidence of fraud you may be charged with civil fraud and hit with a 75% penalty on any tax underpayment.
Negligence: Failing to keep records and substantially understating your income could result in $5,000 or 10%, whichever is greater, of the tax that should be on the return.
Where to get help if the IRS audits you?
You do not have to face the IRS alone. You have the right to hire a tax representative to assist you. You should exercise that right, particularly if you owe thousands of dollars in taxes or may be charged for tax evasion. Be careful when selecting a tax relief company or tax professional to represent you. Only employ companies that hire tax attorneys, CPAs, and enrolled agents. Check their BBB accreditation, customer care reviews, and financial strength. Choose companies that provide a free initial consultation and offer a money back guarantee.
IRS audits are stressful. A notice of examination from the IRS can have the toughest taxpayer shaking in her boots. But it doesn’t have to be that way. In some cases, audits result in no changes or even in a larger tax refund. Although it is technically possible to represent yourself, this is not a good idea when you may be charged for tax evasion or a large tax debt is at stake. You have the right to hire a tax representative. Exercise it.