We all cringe when thinking of that dreaded “Notice” letter from the IRS. No urgency to worry yourself though, stay calm and understand that the analysis is a professional procedure that may be resolved by simply having the appropriate, professional representation, presenting the correct paperwork.
More than 1 million taxpayers face an IRS audit of their individual tax return in 2017, but that only includes less than 1% of all returns.
Knowing what to expect can benefit you in accurately assisting your IRS representation in addressing errors, handling numerical discrepancies, communicating respectfully with IRS representation agents and completing the process with only a moderate level of stress.
Why the IRS May Contact You?
Taxpayers should first realize that an audit in no way suggests suspicion of criminal activity. Tax returns are perplexing documents containing financial data that must be evaluated to confirm accuracy. The process is known as an examination and does not imply that you have deliberately made an error. The fact is the IRS does contact individuals for a variety of reasons.
Taxpayers are picked through a random selection and computer screening process, according to the IRS, that is based on a statistical formula. The IRS compares tax returns against the norms for similar returns. If your return doesn’t follow the “norms” you may be chosen for an audit.
If your tax filing includes transactions with other taxpayers, such as business partners or investors, and they were audited, you also may be audited.
Other reasons you may be audited:
- Foreign currency transactions or bank accounts
- Conflicting third-party reports regarding income on 1099s, W-2s
- Business use of a vehicle
- Home office deductions
- Rental losses
- Hobby-related deductions (also known as hobby losses)
The 3 Types of Audits.
Determined by the level of severity, there are three types of audits. Most audits are nothing serious, and more than three-quarters of audits are completed through the mail, according to news reports.
Correspondence Audit (Mail) – Routine errors from incorrect math or missing paperwork are often handled through correspondence.
Office Audit – An office examination is scheduled at a local IRS branch where they will commonly try to find out if you reported all your income and that your deductions are appropriate.
Field Audit – A field audit is the most extensive of the 3. An IRS agent will pay a visit to your home, business or accountant’s office to review records and files in order to confirm that your tax return information is correct.
Preparing for an Audit
If you are being audited, the IRS will contact you by mail, not by phone or email. Contained in the letter will be a great deal of specific information that is to be examined and what supplementary documents you may need to present.
You have 30 days to respond to an audit notice. Do not put off your response, as the time you spend ignoring a letter can be time that interest builds on the amount you owe the IRS. A professional knows how to abate the penalties.
Before an audit, you need to get your paperwork ready, seek to understand what the problem is and contact your professional IRS representation.
Your Professional IRS representation will gather the forms the IRS has requested. Your representation will want to make sure you have copies, not originals. Coordinate paperwork, and make sure the documents match up with the year that is under review. If realized that certain records have been misplaced immediately call and request that duplicates be sent to you.
Documents you may be asked to bring can include:
- Home mortgage statements
- Previous tax returns
- Brokerage statements
- Retirement account records
- Pay stubs
A tax professional will review your documents and make sure you understand what the miscalculation might be.
During the Appointment: Know Your Rights
For the actual appointment, you can attend by yourself or opt for representation to attend in your place or alongside you. It may be costly, but a certified public accountant, attorney or IRS Enrolled Agent or paid preparer of your return can represent you. A response to the IRS from a tax professional does a couple of things.
- It lets the IRS know that the taxpayer is represented by someone who understands their rights.
- A professional understands how to preserve your appeal rights.
During the audit, which will take place in person at an IRS office, you should be polite and compliant. Only show the IRS agent documents that are specifically requested.
At the same time, you have rights and deserve fair treatment. Here are your taxpayer rights during the audit process, according to the IRS:
- A right to courteous and professional treatment by IRS agent.
- A right to privacy and confidentiality about tax matters.
- A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.
- A right to representation, by an authorized representative.
- A right to appeal disagreements, both within the IRS and before the courts.
After the Audit
An IRS audit may end with no changes, an agreed-upon change or changes that the taxpayer disagrees with and appeals.
After the interview, the examiner will present with a computer-generated audit report, which will include the amount of additional tax that is assessed, an explanation of how your return will be changed, options for how you can appeal the report and a space that indicates whether you consent or disagree. By signing the report means you are giving up your right to go to Tax Court.
If you are unsure whether you agree with the report, you do not have to sign it. You can request to speak with the agent’s supervisor to review the documents further. If the IRS changed your tax return, it is highly recommended to find professional representation to help you and acquire your transcript from the IRS.
Any tax deficiency will accumulate interest at a rate of 5% per year from the date of the original return until you pay the bill. The interest is compounded daily. The IRS examiner will often have this information prepared, showing the total owed.
Based on the type of errors discovered during the audit, you could also face a penalty of up to 25% of the deficiency, and, for fraud cases, possible imprisonment.
What If I’m Unable to Pay?
Penalties and tax deficiencies can hike your tax bill to an unaffordable amount, but don’t worry, you can do one of three things.
- Get an extension
- Monthly payment plan
- Qualify for IRS Fresh Start
Common Myths About Audits
TV shows and movies have created a myth about tax audits. Just the word audit strikes fear in a lot of people. However, they aren’t as dramatic as what you see on the screen. It’s a much more clinical process.
Some common misconceptions about tax audits are that they only go after the wealthy, certain deductions will trigger an audit and that professional tax preparers are audit-proof. These are overblown.
While it is true, statistically, that the higher your income, the more likely you are to be audited, there is still the possibility of an audit for those with lower incomes. Less than 1% of tax payers with under $500,000 in annual income were audited in 2017, but the IRS still audited .71% of returns filed by those who made under $25,000.
The percentage increases substantially if your annual income is over $1 million. Nearly 15% of taxpayers that made over $10 million per year were audited.
Many times, an audit won’t happen in the year you file. It could be two or even three years after, but can be expanded to older years for statutory reasons.
Protect Yourself in Case of an Audit
Simply keeping all your paperwork can prepare you for a possible audit. Here are some basic steps to keep your records in order:
- Keep tax returns and records for three years minimum, 6 years preferred.
- Save your checkbook registers.
- Organize receipts by date for major purchases.
- File bills in folders.
- Journal and keep evidence of deductible information.
- Keep tax documents in one location.
In addition to knowing where all your documents are, take the initiative to compare your tax liability to the national average in your occupation. Having an idea of how much you should pay in taxes can guide you in evaluating if your taxes are properly complied. Sometimes double-checking for accuracy and an IRS professional representation can help you avoid a lengthy, and sometimes costly, process.