Nobody wakes up in the morning hoping that a notification letter from the Internal Revenue Service (IRS) is waiting in the mailbox. However, the reality is that IRS data shows that close to one million Americans are subjected to tax examinations each year. The good news is that understanding how the audit process works can help people avoid audit triggers, understand their rights, and respond properly if and when audits do happen. Take a look at what every taxpayer needs to know about IRS audits.
What Is an IRS Audit and Why Is Someone Typically Selected?
The IRS has the right to audit the tax returns filed by all businesses and individuals. An audit is a closer examination of a tax return that has been filed, though it is not an indictment of any kind regarding the accuracy or legitimacy of that tax return. You don’t have to be a millionaire, mogul, or a high-profile person to be the subject of a tax audit.
Of course, most people will breeze through life without ever receiving a notice for an audit. Others are not so lucky and may even end up owing the government money. What could potentially trigger an audit for a specific person or business? Several factors are in play when it comes to how and when IRS audits are triggered.
The IRS uses “red flags” that are spotted on tax returns to decide which returns will be audited each year. This means that anything that appears to fall outside of the ordinary could trigger an audit. For instance, a return that shows a low-income level with high deductions could result in an audit notice.
Here are some common factors that trigger audits each year:
- Math mistakes
- Numbers that appear too “neat” or “round” throughout a return
- Unreported income
- Early withdrawals from retirement funds
- Higher than normal charitable deductions
- Higher than normal work-related deductions
- Broken rules for foreign accounts
- Incomes higher than $200,000
- An unusual number of dependents
- Overlapping tax associations with people or businesses that have been audited
Owning a small business or shares in a limited partnership can also increase a person’s odds of being audited.
Keep in mind that the IRS doesn’t scan tax returns by hand to spot oddities; instead, it uses a computer system designed to spot areas of concern on returns. This system is called the Discriminant Information Function (DIF). Nobody is safe from the DIF – every single return received by the IRS is scanned through it. In addition to scanning information, the DIF is capable of comparing returns from different taxpayers to pinpoint inconsistencies.
How Are You Notified of an IRS Audit After You File Your Taxes?
The IRS notifies taxpayers of audits exclusively by mail. This means that any notification you receive by phone or email is probably part of a scam. An IRS notification letter typically asks the recipient to answer specific questions or explain the details of a tax return. Here are some characteristics of a genuine audit letter from the IRS:
- It arrives via certified mail
- It contains the taxpayer’s correct name
- It contains the taxpayer’s taxpayer number
- It contains an employee number
- It has a form number
- It provides contact information that a taxpayer can use to reply to the IRS
Remember that an IRS representative will never demand instant payment of owed taxes, and that a request like that could be a sign of a scam. Every taxpayer has the right to receive courteous treatment from IRS agents. In addition, taxpayers have a right to know why the IRS is asking for information, how that information will be used, and what the consequences will be if a taxpayer refuses to provide information.
What Is the Audit Timeline?
The specific timeline of an audit will depend on numerous factors. Agency backlogs, appeals, and the complexity of a particular audit all play roles in determining the length of the audit process. The life cycle of an audit is rarely more than a few weeks, but the IRS technically has up to three years to complete a full audit.
Quickly answering all correspondence from the IRS can help ensure that the audit process does not get drawn out. Interest can continue to add up during the length of an audit if a taxpayer has a delinquent tax. In short, longer audits can cost extra money for people who owe taxes.
It is important to know that tax audits are not exclusively conducted for just the previous year. Audits are typically triggered within two years of a return being filed, but the IRS can go as far back as six years when pulling tax returns for auditing purposes.
How Is an IRS Audit Conducted?
The IRS uses several methods to conduct audits. Some people who are audited go through correspondence audits. This means that all forms, supporting documents, and necessary payments are exchanged through the mail, and no in-person meeting is required.
However, the IRS may decide to conduct an audit through an office or field audit. An office audit requires the person being audited to meet with an IRS representative in person at the nearest IRS office for an interview that typically involves answering questions and providing supporting documentation. A field audit means that an IRS agent will visit the person being audited at their home or place of business.
What are the major differences between a correspondence audit and an office or field audit? A correspondence audit typically focuses on one specific error or issue within a tax filing. An in-person audit, however, occurs when the IRS has a number of questions regarding what is contained within a tax return. The in-person interview scheduled during an office audit is often used as a time for agents to gather supporting documentation and clarify questions about the filing. The general recommendation is that a person should not attend an audit interview without an authorized tax representative to provide support. A field audit, on the other hand, will involve an IRS agent coming to the audited person’s home or place of business, or wherever the relevant records are kept. Field audits are usually conducted when the IRS suspects fraud or has more serious questions about the legitimacy of a tax filing and must gather on-the-ground information.
How Do You Avoid Getting Audited by the IRS?
The fact of the matter is that it’s impossible to be fully inoculated against IRS audits. A small percentage of audits are done totally at random. However, most audits are triggered by “red flags” that can be avoided. The easiest way to avoid an IRS audit is simply to file honest, accurate returns. Don’t forget that simple mistakes like incorrect calculations or failing to sign a return can increase the odds of an audit.
If you think your tax return may contain some of the red flags that trigger audits, it’s wise to get ahead of the problem. You can and should provide explanations for any details that could look problematic. Including receipts with a return is a smart way to provide documentation. You can also submit extra forms and worksheets with a return to clarify why some numbers look the way they do.