IRS Audits: Everything Your Tax Lawyer Wants You To Know

IRS audits in the United States are when the IRS examines your tax returns to make sure you're following the tax laws. While they don't publicly share all the specific stats, we can get a general idea of what's happening.

Small business owners and self-employed folks also tend to face a greater audit risk, specifically if you report only losses. Of course, it's important to remember that audit risks can vary depending on factors like your income level and your industry. Knowing these trends can help you be aware of the potential for an audit and ensure you're reporting your taxes accurately.

What is an IRS Audit?

An IRS audit is when the Internal Revenue Service (IRS) examines your tax return to make sure the information you reported is accurate and in line with tax laws. Audits are conducted to ensure compliance with tax regulations. There are three main types of audits:

Field Audit

This is an in-person audit that takes place at your business location, your accountant’s office, or another agreed-upon spot. During a field audit, an IRS agent will review your financial records, such as receipts, invoices, and financial statements. They may also interview you or your representatives to gather more information about your financial situation.

Office Audit

An office audit occurs at a local IRS office or audit center. You will be asked to bring specific documents and records to the IRS office for review. Office audits are usually less extensive than field audits and focus on specific issues that can be resolved without major disruptions.

Correspondence Audit

Also known as a mail audit, a correspondence audit is conducted through written communication. The IRS will send you a letter requesting certain documents or information related to specific items on your tax return. You’ll need to respond by mail within a given timeframe, providing the requested documentation. Correspondence audits are generally limited in scope and often deal with simpler matters, such as verifying deductions or requesting additional supporting documents.

Keep in mind that the type of audit you face can vary depending on the complexity of your return and the issues identified for examination. In some cases, a combination of audit types may be used to review your financial affairs thoroughly.

What Triggers IRS Audits?

While the IRS doesn’t disclose their exact selection process, certain things might catch their attention and increase the likelihood of an audit:

High Income

The IRS might be more inclined to audit your return if you earn a substantial income. Higher incomes often involve more complex financial transactions and a greater potential for significant tax liabilities.

Mistakes and Discrepancies

If there are significant differences between the income you report on your tax return and the information provided by employers, financial institutions, or other parties, it can raise eyebrows. Also, frequent errors in your calculations or inconsistencies in your filings might make the IRS take a closer look.

Unreported Income

Failing to report all the income you receive, especially cash transactions, freelance work, or rental income, could become a trigger for an audit. The IRS has access to various sources of information and can compare the income you reported with data from employers and other entities.

Abnormal Deductions or Inflated Expenses

Claiming unusually large deductions, especially if they’re disproportionate to your income or industry standards, might raise suspicions. Deductions that lack proper documentation or seem excessively high compared to your financial situation could be subject to scrutiny.

Self-Employment and Small Businesses

If you’re self-employed or own a small business, the IRS might pay closer attention to your return. They are more cautious about potential underreporting of income, overstating of deductions, or misclassifying employees as independent contractors.

Foreign Accounts and International Transactions

Failing to report income or assets held in foreign bank accounts, as well as not complying with tax obligations related to international transactions, can increase the chances of an audit. The IRS has been actively targeting offshore tax evasion and non-compliance.

Prior Audit History

If you’ve been audited before and issues were found, the IRS may keep a closer eye on your future returns to ensure compliance.

Random Selection

Sometimes, tax returns are chosen for audit randomly as part of the IRS’s efforts to maintain overall tax compliance.

The presence of these factors doesn’t automatically mean you’ll be audited, but they can increase the likelihood. It’s important to accurately report your income, maintain proper documentation for deductions, and be transparent in your tax filings to minimize any audit risks.

How Far Back Can the IRS Audit You?

The IRS generally has a certain timeframe to audit your tax returns. Typically, they have three years from the date you filed your tax return (or the due date if you filed late) to initiate an audit. However, there are a few situations that can extend this timeframe:

If you underreported your income by 25% or more, the IRS has up to six years to audit your returns. When it comes to fraud or suspected tax evasion, there’s no specific time limit. In such cases, the IRS can audit any tax return, regardless of how far back it was filed. If you didn’t file a tax return at all, there’s no time limit. The IRS can initiate an audit for any year in which you failed to file.

It’s worth mentioning that the statute of limitations works both ways. Once the applicable time period has passed, you generally cannot claim a refund or credit, and the IRS cannot assess additional taxes unless there are specific exceptions. It’s best to seek guidance from a tax professional to get a better understanding of your situation and any potential audit risks.

Who Gets Audited By the IRS the Most?

While the IRS doesn’t openly provide detailed statistics on audit demographics, there are some general trends based on available information. It appears that individuals with higher incomes are more likely to face audits since they often have more complex financial situations and potentially larger tax liabilities. According to IRS data from 2022, people with an adjusted gross income (AGI) between $1 million and $5 million had an audit rate of 1.3% whereas people with an AGI greater than $10 million had an audit rate of 8.7%.

Moreover, self-employed individuals and small business owners might receive closer attention due to the potential for underreporting income or misclassifying employees. It’s important to remember that audit rates can differ based on factors like income level, the nature of income, and compliance history.

What Happens When the IRS Audits You?

When the IRS audits you, several steps are involved in the process. Here’s a breakdown:

Notification

You’ll receive an official notice from the IRS letting you know that your tax return has been selected for an audit. The notice will mention which tax years are under examination and provide details on the requested documentation or information. It should also include contact information for the assigned IRS agent.

Preparation

Once you receive the audit notice, it’s important to gather and organize all the necessary documents and records that support the items you reported on your tax return. This includes things like financial statements, receipts, invoices, and bank statements.

Initial Contact

You’ll need to get in touch with the assigned IRS agent based on the instructions provided in the audit notice. This contact can happen through mail, phone calls, or even in-person meetings, depending on the type of audit.

Information Request and Documentation Submission

The IRS will ask you for specific documents and information related to the items they’re examining. You’ll need to submit these requested documents within the given timeframe, making sure they are all well-organized and easy to read.

Examination and Interviews

The IRS agent will review the documents you’ve submitted and may conduct interviews to better understand your financial situation and the items being audited. These interviews can take place in person, over the phone, or through written correspondence. It’s important to provide truthful and accurate information during these discussions.

Issue Resolution and Negotiation

If the IRS agent identifies discrepancies or issues during the examination, they will communicate their findings to you. You’ll have the opportunity to address these concerns, provide explanations, and present additional documentation to support your case. You may engage in negotiations with the agent to try and reach a resolution.

Proposed Changes and Appeals

After the examination, the IRS will propose changes to your tax return if they believe adjustments are necessary. They will send you a written explanation of these proposed changes, along with information on your appeal rights. If you disagree with the proposed adjustments, you can file an appeal and present your arguments to an independent IRS appeals officer.

Resolution and Payment

If an agreement is reached between you and the IRS, or if the appeals process concludes, you’ll receive a final examination report outlining the agreed-upon changes. If you owe additional taxes as a result of the audit, you’ll be provided with instructions on how to make the payment. Keep in mind that interest and penalties may apply to any unpaid amounts.

How Long Do IRS Audits Take?

The duration of an IRS audit can vary quite a bit depending on different factors. It really depends on the complexity of the issues being examined, the amount of documentation involved, and the availability of both the taxpayer and the IRS agent. Some audits can be resolved in just a few weeks, while others may drag on for several months or even years. It all depends on the specific circumstances. Simple audits with fewer issues can often be wrapped up more quickly, but when there are complex matters or lots of documents to review, it can understandably take longer. It’s worth noting that the IRS does have guidelines for completing audits within a certain timeframe, but sometimes unexpected situations or the need for further investigation can stretch things out.

How Can a Tax Attorney Help With an IRS Audit?

A tax attorney can be a real lifesaver during an IRS audit. Find one using the Expertise.com directory. Here’s how they can lend a helping hand:

Expert Advice and Guidance

Tax attorneys are pros when it comes to tax law. They have deep knowledge of the tax code and can provide you with clear and up-to-date guidance. They'll help you understand the audit notice, break down the relevant laws, and walk you through each step of the process in plain language.

Communication and Representation

Dealing with the IRS can be stressful, but with a tax attorney on your side, you don't have to face it alone. Your attorney will act as your representative, handling all the back-and-forth with the IRS. They'll communicate with the IRS agent, respond to their requests, and negotiate on your behalf. Having someone experienced in your corner takes a weight off your shoulders.

Strategy and Documentation

Your tax attorney will help you come up with a solid game plan for the audit. They'll assist in gathering and organizing all the necessary documents to support your case. They'll review your records, spot any potential issues, and strengthen your position. With their expertise, they'll make sure you present your side of the story convincingly to the IRS.

Reducing Penalties and Liabilities

If the IRS proposes changes or penalties, your tax attorney will be there to help minimize the impact. They'll assess the validity of the proposed adjustments and advise you on the best approach. If penalties are on the table, they'll fight for penalty abatement or work out a reasonable resolution to keep your financial liabilities in check.

Appeals and Litigation

Should you disagree with the audit outcome, your tax attorney will guide you through the appeals process. They'll help you prepare a strong case and present it to an independent IRS appeals officer. If things escalate to tax court, your attorney will be your advocate, presenting arguments and fighting for your rights.

In a nutshell, a tax attorney's expertise, experience, and knowledge of tax laws can make a world of difference during an IRS audit. They'll be your trusted ally, protecting your rights, making sense of the complexities, and working tirelessly to achieve the best possible outcome for you.