Navigating IRS Audits
Note - This article is not intended to provide legal or tax advice of any kind. It is purely intended to help educate visitors on the various types of tax audits. If you have specific questions about an audit you have received, please speak with your CPA or a tax attorney.
An audit, as it pertains to taxes, is an official examination of a taxpayers filings. There are two common types of IRS audits the Internal Revenue Service performs; paper and in person with each handled differently.
The first of the two, the paper audit (also called an IRS notice letter), occurs much more frequently than in-person audits. About 1% of all returns are audited, the majority of which are done via paper. In the event that a mistake/error was made on a filing, a notice is sent to the taxpayer making them aware of the issue along with the result of the mistake (usually a balance due). Most often, these are notices saying that they have checked, found errors, recalculated the tax bill and this is what they believe the difference to be.
The taxpayer is usually asked to agree to one of the following: accept the changes in entirety, accept part of them, or if they disagree with the changes, provide additional documentation supporting this. Most often, the errors are just a case of human error. Either the taxpayer forgot to report some of their income (stock sale, interest, contract work, etc), or (if they choose to calculate the return themselves) it contained inaccurate math.
In-person audits are usually reserved for more complex or egregious discrepancies. The process begins with a notice being sent asking the filer to call and set up an appointment with the agency. The agent will provide details on the issue in question and ask that you meet to discuss it. Often, the documents required will be specified in the original notice, but may be clarified if necessary over the phone.
Appointments are typically set with enough time to ensure the person can prepare all necessary documentation. If a CPA was used on the original filing, notification of this request is usually sent to them as well. Most times the filer will include their CPA and sometimes a tax attorney in the proceedings.
With either type of audit, a taxpayer should not delay response. If they plan on challenging the changes it is worth noting that, in most cases, a "non response" indicates acceptance of the changes. If more time is necessary, it is certainly acceptable to request that.
How to Avoid Triggering an IRS Audit
The IRS processed an estimated 280.6 million withholding documents for tax year 2014. Because of this, the IRS only has the time and resources to take a closer look at a very small percentage of tax returns. This "closer look" is referred to as a tax audit.
An audit attempts to verify that a taxpayer's income and deductions are accurate. There are certain aspects of a tax return that can more frequently trigger an audit. Below are a few of the items that may trigger an audit.
- Significant changes in income from year to year. If a taxpayer reports a lot less or a lot more income, the IRS may choose to take a closer look at the return. This includes:
- Unreported income, the IRS should receive a copy of all W-2, 1099 tax forms. If a taxpayer does not include one of these areas of income, it will often trigger a closer look by the IRS.
- Large itemized deductions, may also be a red flag for the IRS.
- Excessive business expense deductions. Business owners want to take full advantage of the deductions available to them, but some claimed deductions may toe the line. The IRS has information and charts that show the average business deductions for businesses at certain income levels. If business expenses are above this average, a return may get flagged.
- Self-Employed Individuals. If you have a home office and significant business expenses, but not much income, then the IRS will likely be more interested in your return. They want to be sure that your business is legitimate and not just a way to decrease taxable income from other sources. If you own rental properties and claim a loss of income, then the IRS may look at your tax return a little closer as well.
Be sure to report all of your income and keep your business expenses reasonable, and you will better your chances of avoiding an audit. Accuracy is important, so report income and expenses exactly as they appear in your documentation. You should also keep documentation that shows expenses and income in the event of an IRS audit.
How to Appeal a Tax Dispute
If the IRS has audited your return, made a tax determination and you don't agree with it, you can appeal. Appealing may be worth the time and effort when large sums of money are involved or where future tax obligations are affected.
If you plan to appeal, most taxpayers find the best first step is to visit the Office of Appeals. The Office of Appeals is an independent organization, created in 1927, to deal with tax controversies in an effort to decrease tax litigation costs for both individuals and the government.
These professionals help individuals and businesses resolve tax disputes with the IRS without the time and expense associated with taking a case to Tax Court. The process of using the Office of Appeals is less formal than going to court, and it is typically more efficient as well. Although the service is offered through the IRS, the professionals in the Office of Appeals do not take sides in a tax dispute. Instead, they attempt to offer an unbiased third party.
The Office of Appeals deals with many federal tax issues, including collections and assessments. Whenever the IRS makes an assessment, the Office of Appeals can be utilized.
IRS Audit Appeal Process
In a decision letter, the IRS will explain your rights to appeal their decision. If you do not agree with the decision, you can avoid signing the agreement form. You should, however, explain why you disagree with the decision when appealing it. Please note, it is not enough that you are dissatisfied with the decision.
There are two types of appeal requests. If the money involved is less than $25,000, then the appeal is for a small case. If it is over $25,000, then you will need to go through a formal written protest. In a small case, you should send a letter to request an appeal. Within that letter, state the changes that you do not agree with and why you do not agree. Use Form 12203 to provide this information.
In a formal written protest, you must include additional details and information beyond the reasons that you do not agree with the decision. You should state facts and provide evidence. If appropriate, cite the law or authority upon which you are relying. You will also need to sign the form under the penalty of perjury.
5 Things to Consider if You Are Audited
First, understand that the IRS does not notify taxpayers by phone, text or email that a return has been selected for audit . While the agency can use private debt collectors to contact taxpayers about overdue payments with installment plans and other agreements, the IRS only notifies taxpayers by mail on official letterhead of intent to audit.
What to Do?
The IRS letter will request specific information it wants to examine, including bank deposits or proof of expenses and deductions. It will provide instructions on how to contact the agency and a deadline when to do so.
Here are steps to take:
- Respond Quickly: Contact the IRS immediately. Responding does not mean answering questions or providing any information. It merely acknowledges that the notification has been received and that the questions will be addressed. Not responding at all doesn't mean the audit will go away. It just means the audit will be conducted without the information being requested.
- Consider Obtaining Professional Help: Unless the audit can be averted by amending an obvious error or providing a document, the standard advice is to seek professional representation. Further, a professional can represent an audited client without the individual being present.
- Although it is critical to respond after initial contact, take as much time as needed. The IRS can typically only go back three years in auditing returns, so the longer the process is stretched out, the narrower the time span may be for the audit.
- Only provide documentation that is specifically requested. Never provide original documents, only copies. Always insist on getting copies of information in the auditor's files or copies of anything you sign. Respond only to questions asked. If unsure how to answer, don't answer.
- Unless totally satisfied with the audit results, you may not wish to sign the agreement, because once signed, it's a done deal.
The IRS Collection Process
If the audit results in a debt, the IRS will confirm it in a letter stipulating taxes owed, plus interest and penalties. If there is no response, it will be followed by a second letter. If that fails to elicit acknowledgment, the IRS will begin collection proceedings.
Among ways the IRS can recoup the debt is by applying tax refunds to the unpaid bill, garnishing wages, or seizing property and assets. Therefore, always pay tax owed as quickly as possible. If that isn't possible, apply for an installment agreement which the IRS can arrange online, by phone or by mail.
Q&A: What do I do if I'm audited?
If you get a letter from the IRS informing you that you are being audited, it is important that you first understand your rights. When audited you have the right to:
- Courteous treatment by all US Treasury employees
- Privacy concerning the audit
- Know why the IRS is requesting certain information and the consequences for not providing it
- A tax or legal professional to represent you
- Appeal a finding that you disagree with
When an audit is received a response is typically required by a certain date. In addition to rights listed above, you can also request more time to respond and the IRS may grant you an extra 30 days.
Being audited does not necessarily mean that you will end up owing additional money to the IRS. It does typically mean that the IRS wants additional paperwork to help verify the information previously submitted. If you do owe additional money, it may be possible to work out a payment schedule.