IRS Tax Audits: All You Need to Know
Nobody likes to hear the word “audit,” and that’s understandable. It’s no secret that audits can have one bathed in sweat. And while some audits can prove arduous, some are just no big deal.
Things aren’t any different for IRS tax audits. All you need is a little understanding of how the IRS works and what these tax audits are. That way, you can have a good sense of what they entail, and you’ll thus be more comfortable.
So, what are IRS tax audits anyway, and how do they work? What are the different types? And how can you get through them? This article will cover all that, along with more information on the subject. Let’s jump right into it.
What are IRS Tax Audits?
Generally, audits are conducted to identify any inaccuracies or discrepancies in taxpayers’ financial documents. An IRS tax audit isn’t any different. It is a review of a taxpayer’s tax returns and financial records to collect any unpaid taxes and ensure information accuracy and completeness.
Only a small portion of personal returns are subjected to auditing annually, and most of these entail no more than a correspondence exchange. Nonetheless, there exist some exceptional instances that may require one to face the IRS in person.
This is because the IRS can be alerted whenever an individual deposits an amount above $10,000. So, take, for instance, you own an enterprise and made an enormous $10,500 deposit in the last year. After filing your tax return, you must be ready to articulate why and how you obtained the money.
How do IRS Tax Audits Work?
Typically, the IRS audit procedure goes as follows:
- Notification: The IRS will send a letter informing you that your tax return has been shortlisted for audit. The reason for the audit, the audited tax year, and the audit type will all be stated in the letter.
- Collecting Information: You will be asked to provide information and documentation on your tax return. Receipts, financial statements, and other documentation may be requested as part of the information request. Before the audit begins, ensure that you gather all relevant documentation and information for a smooth process.
- Audit Meeting: In the cases of a field audit or office audit, you will be obligated to meet with an IRS agent in person, who will then ask questions about the tax return and review your financial records during the meeting. You must be ready to answer the questions and provide the necessary documentation.
- Information Review: The agent will analyze the documentation and information provided and make any appropriate changes to the tax return. They may also make additional clarification or information requests.
- Audit Results: Once the audit is finished, the IRS agent will issue you a written report detailing the audit results and any changes made to the tax return. If you owe additional taxes, you will be required to pay them. However, if one disagrees with the audit’s findings, they have the right to file an appeal.
It is essential to note that the IRS audit process may prove time-consuming and can take up to several months to complete. Even so, the process can be made seamless by keeping accurate records, cooperating with the agent, and being prepared. Suppose you have any questions or concerns during the audit, you may want to consult a tax professional.
Types of IRS Tax Audits
Based on the circumstances, an IRS audit can take several forms. The following three are the most common.
Correspondence Audit
A correspondence audit, otherwise known as a mail audit, is the most common type of tax audit conducted by the IRS. It entails the IRS sending a letter to the taxpayer requesting specific documentation or information related to their tax return.
The taxpayer may then respond to the request either online or via mail, after which the IRS will examine the information to see if there exist any errors or discrepancies in the tax return. Often, correspondence audits are used to address particular tax return items such as credits, income, or deductions.
Office Audit
An office audit is a one-on-one meeting between an IRS agent and the taxpayer. It is typically performed at a local IRS office and is reserved for more elaborate tax returns that demand a more comprehensive review.
The IRS officer will ask questions, evaluate the taxpayer’s financial documentation and records, and make any necessary modifications to the tax return during the audit. The taxpayer is obligated to provide all relevant information and documentation.
Field Audit
A field audit is a more in-depth audit that takes place at the taxpayer’s residence or business premises.
It is used when the taxpayer fails to reply to a prior correspondence audit or when the IRS is still doubtful about the accuracy of a tax return. In this audit, the IRS agent will review business practices, financial documents, and other records associated with the tax return.
Common Reasons Behind IRS Tax Audits
The IRS carries out tax audits to minimize the difference between what the bureau receives and what it’s owed, otherwise known as the “tax gap.” While these audits may be random, the IRS often picks out taxpayers based on unusual activity.
We detest deception. However, we are also opposed to incurring more than you owe. The following are the most notable red flags that can easily put you across the IRS audit firing line this tax season.
Claiming Too Many Contributions to Charity
Suppose you made considerable charity donations; you may cut it for some well-deserved tax deductions. But as a general rule of thumb, you cannot report falsified charitable contributions.
In other words, don’t claim your donation if you lack the necessary documentation to back its validity. It’s really that simple. Claiming $20,000 in charitable deductions on a $60,000 salary will almost certainly cause some consternation.
Failure to Report Some Earnings
One quick way to attract an IRS audit? Fail to report a portion of your earnings.
Take an example. You’re an employee at Jake’s construction firm, and you supplement your income by writing blogs for a building and construction publication as a freelancer. You might be inclined to submit only the W-2 form from your construction job and conceal the freelance earnings on your Form 1099.
1099 reveals nonwage income sources such as interest, stock dividends, and freelancing. The 1099-NEC, a type of 1099, usually reports payments made to independent contractors.
Because the IRS already has a copy of the income listed on your 1099 (obtained from the publication), it’s only a question of how long before it uncovers the omission.
Making Math Errors
Whenever the IRS commences an investigation, “oops” doesn’t suffice. Avoid any errors. This pertains to anyone who is mandated to file taxes. Don’t get sidetracked, causing you to overlook the last zero or make the mistake of writing a 3 instead of an 8.
Errors occur, but that’s not an excuse when doing your taxes, and you will be fined whether or not your blunder was deliberate. So, be sure to triple-check your figures.
Suppose your math is a bit sketchy; employing a tax preparer near you or good tax preparation software is an excellent idea. This could save you from making costly mistakes that may result in an IRS audit.
Debiting Too Many Work Expenses
Documenting too many business expenses is pretty much like documenting too many losses. Expenses must be 1) standard and 2) necessary to your business for them to be deemed deduction-eligible.
For instance, a pro artist can claim paintbrushes and paint as they fulfill the criteria. On the contrary, a doctor with a hobby for painting and who doesn’t profit from his work may face trouble if he does the same.
So, before deducting a purchase, ask the following questions: Was the expense ordinary and accepted in the business? Was it relevant and beneficial to the business or trade?
Too Many Losses Reported on a Schedule C
This applies to self-employed individuals. If you own a business, you may feel the urge to conceal your earnings by claiming personal expenses as business expenses.
However, before writing off your new snowboard boots, contemplate the suspicion that a significant number of reported losses can evoke. The IRS could start to question how your company is enduring. You can find more details about this in IRS Publication 535.
Using Tidy, Round Figures
The figures on your 1040 form and other necessary documents are unlikely to be in simple, tidy $100 increments. Be accurate in your computation, and don’t make estimations. Don’t round to the nearest hundred, but to the nearest dollar.
Let’s assume you’re a professional photographer and wish to claim a $585.35 lens as a business expense. In this case, round that up to $585, not $600. A clean $600 is somewhat improbable, and the bureau might request confirmation.
Claiming a Home Office Tax Break
Home office deductions are regularly abused. You may be tempted to claim unjustified tax breaks for expenses that aren’t technically eligible. The IRS limits the home office deduction to individuals who utilize a part of their residence “exclusively and regularly for your trade or business.”
As such, you can only qualify for a home office deduction if you use your home office for business purposes and nothing more. Responding to emails on your laptop in front of your 84-inch flat-screen TV on occasion is unlikely to make your living space eligible for home office deduction.
But if you’ve set aside a portion of your household solely for work purposes, you may be able to claim a home office deduction. Remember to be honest when reporting measurements and expenses.
Surviving IRS Tax Audits
If you’re subject to an audit, the best course of action is to learn about the process, understand the reason behind the audit, and know your rights and responsibilities. Here are a few things to know to survive an IRS tax audit.
- It is critical to understand your legal rights.
During an IRS tax audit, a taxpayer has the right to:
- An explanation of the auditing procedure
- Representation by an enrolled agent, CPA, or attorney
- Claim any supplemental deductions that you may have missed on your tax return
- Request a national office opinion from the IRS on specific technical concerns that emerge during the audit
- An audit doesn’t mean you’re being charged with wrongdoing.
An IRS audit on your tax return doesn’t translate to you being charged with a crime. The audit is just an objective review of your tax return by the bureau to verify its accuracy. You must show that you disclosed all your earnings and were eligible for all the exemptions, deductions, and credits listed on your return.
- You can appeal to dispute the audit results
If you concur with the audit’s outcomes, all you’ll have to do is fill out some paperwork and pay the additional taxes. However, if you disagree, debatable items can be discussed through Alternative Dispute Resolution or with the auditor’s supervisor.
If the mediation doesn’t do it, you can appeal to the IRS Appeals Office, which is separate from the local office that audited your return. To do so, you must send a protest letter to the IRS no later than 30 days after the audit report was issued.
If still unable to resolve the matter with the appeals officer, you may proceed to take your case to your local US District Court, US Court of Federal Claims, or US Tax Court.
Consult With a Tax Attorney Today
Trust us; we know. IRS tax audits can be overwhelming to understand, let alone handle it yourself. And while that’s an option, it may not prove as favorable as having a professional tax attorney help you manage the matter.
At Cumberland Law Group, we boast seasoned tax attorneys who can help with anything revolving around civil and criminal tax matters. Regardless of how complex your situation is, you can count on our tax attorneys to help manage and resolve it. That said, contact us today and let us help.