How Do IRS Audits Work?

The term "audit" will make someone break out in a sweat, but you can get more comfortable with a little knowledge of what it is and how the Internal Revenue Service (IRS) functions. There's no big deal with other audits; some can be onerous. When you recognize the type of tax audit that is being carried out you will know what's involved, or at least have a clearer understanding of it.

KEY TAKEAWAYS

Understanding the different types of IRS audits can help you handle them.
An audit of correspondence is handled by letters. The simplest kind literally states that you owe more funds. For records, a more extreme form asks, usually to support a deduction.
The IRS asks you to interview you in person about particular things on your return during an office audit.
An IRS agent comes to your house, your place of business if you're the owner, or the office of your accountant to do a general review of your records in a field audit.

Correspondence Audits

Correspondence audits are handled by written mail, as the name suggests.

The Simple Letter

A simple letter sent by the IRS to you to say that you owe the government money is the first form of correspondence.

While this missive is not an audit technically, the failure to resolve it will cause the initial matter to become one.

A simple letter from the IRS can result from:

On your tax return, a math mistake on your part (for instance, you meant to record $2,500 in income but only reported $500, so you owe taxes on the $2,000 omitted).
An income omission on your tax return that was registered on another form to the IRS (e.g., your W-2 form, 1099 for certain investments or independent contractor wages, or a Schedule K-1 for an interest in a partnership, S corporation, trust, or estate).

You should accept that the mistake was yours and pay the bill (taxes, interest, and in some situations, penalties) if you get such a note, something you can determine for yourself if the error is clear and completely yours. Or you can disagree and continue to further investigate the particular things in dispute (which may continue to be handled by correspondence or on the telephone). If you don't feel comfortable defending your case, you might want to call in a tax professional (e.g., the IRS claims you didn't have revenue on your return that you and your preparer claim is not taxable).

The Audit Letter

The second form of letter you will get from the IRS is one seeking a deduction or other place taken on your return for some documentation to justify it. This is an actual, though limited, audit: an audit of correspondence. Perhaps the IRS needs to see a written acknowledgment from a charity for a contribution you made and deducted; for another deductible cost, you might need to include a canceled check or credit card receipt. Mailing in the requested proof will fix the problem quickly.

You will want to pay up in order to close the matter if you do not have the facts (e.g., the amount involved is minimal and you believe your time is better spent in other pursuits). You can continue to argue your point through IRS channels (all of which will be spelled out by the IRS in more correspondence) and finally litigate (if the issue is significant enough to justify your time and the cost of a professional if you choose to have representation).

Office Audit

On particular things on your return, the IRS may want to interview you in person. This is a full-fledged audit and a severity step-up. You will receive a letter telling you on a specific date to come to a specified IRS office (the appointment can be rescheduled for your convenience, as long as the IRS agrees). You can bring for representation a CPA or other tax professional, which might be a good idea to make sure that your activities will not extend the inquiries of the IRS beyond those listed in the audit letter.

No adjustment to your return, or a finding that you owe taxes, or even a finding that the IRS owes you a refund can result from an audit. An unfavorable initial decision is not usually final by the IRS agent you meet with. You have a right to appeal it and go to court if you are still not happy.

Field Audit

This is an investigation where, whether you're the owner or your accountant's office, an IRS agent comes to your house, your place of business. This audit is literally more intrusive (due to the presence of the agent on your turf) and theoretically more invasive (because the audit is not limited to specific items). While such audits are very rare for individuals, it is advisable that you are not alone if you are chosen for this type of audit; have a tax pro (like an attorney) by your side.

Line-by-Line Audits

The most hated audits of all are these. Taxpayers are picked at random to have every line checked on their return. Such audits take place only once in a long while under the National Research Program (NRP). They are carried out to provide the IRS data used to perform potential targeted audits, but extra taxes, interest, and fines are owed by taxpayers who go through them.

The Bottom Line

IRS audit figures show that the chances of being audited are minimal (just over half of 1 percent of individual returns were audited in 2018, just 0.59 percent), while the probability for those with sales over $100,000 is higher. Overall, as of 2017, audits are down 10 percent, and IRS budget and staff limitations make it possible that the likelihood of being audited will only be lower in the near future. Nonetheless, if you are under an audit, know how they function and your rights in the process, which are defined in detail in IRS Publication 556.

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Do You Need Help Getting Ready For An Audit?

Are you terrified of you, your business, or your non-profit getting audited by the IRS? Do you wake up in the middle of the night at the thought of hearing that knock on your door? Call Robert Arnone CPA today so you can get busy relaxing tomorrow! We also handle internal audits, of course. We specialize in helping HOAs, non-profits, small and mid-sized businesses make sure their books are in order so business leaders can sleep better at night. So if you’re even a little concerned, now is the time to act. Contact us today!

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How Do IRS Audits Work?