Receiving notice that you’re being audited by the IRS may send you spiraling into a panic. Take a deep breath.
Experts note that there are strategies taxpayers can use to navigate the system, separate real IRS audits from scams and maximize their chances of a favorable decision.
What Is an IRS Audit?
An IRS audit is a review of your tax forms and financial documents to ensure that you filed your tax return correctly and followed applicable tax laws.
“The purpose of the audit is to determine that the (tax) return is substantially correct,” says Alan Pinck, enrolled agent and National Tax Practice Institute fellow who owns his own tax preparation business with offices in San Jose and San Ramon, California. At the end of the audit, one of three things is going to happen, Pinck says: Either you will owe the government money, the government will owe you money or the auditor will accept the tax return as originally filed. “Unless you do something, or did something, really stupid during the process, nobody goes to jail,” he says.
Still feeling stressed? Here’s what to know about surviving a federal income tax audit.
[See: 15 Tax Questions — Answered.]
How Common Are IRS Audits?
Tax audits, or examinations, aren’t terribly common. In fiscal year 2019, just 0.4% of all individual income tax returns were audited, according to the IRS.
But that low likelihood doesn’t give taxpayers free rein to claim whichever tax credits and deductions they’d like. The IRS will contact you if there are discrepancies between your tax return and the paperwork it has received from your employers, brokerage firms and other sources. It may also initiate an examination if auditors spot certain red flags.
Reasons You May Be Audited
Your tax return may be audited for a range of reasons. The reasons for an IRS audit include:
Random selection and computer screening. “Sometimes returns are selected based solely on a statistical formula,” the IRS says. Your tax return is compared against a sampling of similar returns to determine whether it’s selected for audit.
Related examinations. You may be audited if your tax return is connected with another taxpayer’s return that was elected for an audit.
Additionally, these are some of the red flags that may trigger a tax audit.
— Failing to disclose taxable income. Don’t forget to include each 1099 or W-2 income form. The IRS gets its own copies and may notice that your records don’t match with what it has on file.
— Neglecting to report cryptocurrency transactions. Selling or exchanging virtual currencies, using them to pay for goods, holding them as an investment and other uses generally have tax consequences and may result in tax liability.
— Making typos. An honest error, such as an incorrect Social Security number, can bring extra scrutiny from the IRS. Double-check your work.
— Using lots of round numbers. Be specific when itemizing expenses. A lot of round numbers looks fishy.
— Making math mistakes. If something doesn’t add up, you may hear from the IRS.
Filing your return completely and accurately can help reduce your chances of being selected or increase the odds of a favorable outcome.
[Read: How to File Taxes for Free.]
How Will I Know if I’m Being Audited?
If you’re being audited, the IRS will reach out via mail. “It’s not going to be a phone call. Everything is going to be in writing,” says Morris Armstrong, an enrolled agent in Cheshire, Connecticut.
If you receive a text, email or phone call purporting to be from the IRS and threatening to arrest you if you don’t pay taxes, you’re almost certainly dealing with a scammer, experts say. A real auditor is “not going to text you, they’re not going to email you, they’re not going to threaten to throw you in jail,” Pinck says.
Once you receive notice you’re being audited, don’t ignore it, experts say. Pretending that it doesn’t exist won’t make the audit go away. In fact, ignoring an IRS audit could eventually cause you to owe additional taxes and your bill to go to collections. It could cost you more in penalties and fees down the line. So it’s time to start hunting down supporting documents and potentially seeking out a professional to represent you.
What Happens When You Get Audited?
The IRS can initiate three types of audits:
— Correspondence audit. Conducted via writing and not face to face with an auditor. In fiscal year 2019, nearly 74% of audits were conducted via correspondence, according to the IRS.
— Office audit. You’ll generally have to meet with an auditor in person, Pinck says. Expect to meet at an IRS office and for the experience to last between two and four hours.
— Field audit. The auditor may come to your place of business or records office. Expect this to last a day or longer.
Depending on the type of audit, the taxpayer or her representative will use different strategies to navigate it. The initial correspondence will often confirm which parts of your tax return are being questioned.
And you may not experience any in-person audit activities during the coronavirus pandemic. Due to the health crisis, “the audits have not been face-to-face but (are) phone conversations and mailing in documents,” Pinck says.
When it comes to communicating with the auditor, only answer the questions you’re asked, whether it’s in an in-person audit or via written response, experts say. Try to limit rambling and kill the urge to divulge too much. “Do not give them any more information than you have to,” Pinck says. “If they ask you a yes-or-no question, answer ‘yes’ or ‘no.'”
If you’ve hired a professional to help you navigate the audit, you will likely sign over power of attorney, and you may never even speak to the auditor — your representative will do that for you.
How Far Back Can the IRS Audit?
Generally, the IRS can audit returns filed in the last three years, but if it identifies a substantial error, it may look back further, typically no more than six years, according to the IRS. This is why it’s important to keep records and supporting tax documents stretching back at least three years, Pinck says. You may be asked to supply them during the audit.
Should I Hire a Professional?
Whether or not to hire a professional to represent you is your choice, experts say. But many say it can be worth the cost in all but the most straightforward audits. “It’s really important to get an experienced representative in any situation other than a simple scenario,” says Lance Christensen, certified public accountant and tax practice leader and partner at Margolin, Winer & Evens in Uniondale, New York.
If you decide to hire a tax professional, consider hiring an expert such as an enrolled agent, certified public accountant or attorney who specializes in audit representation. “Most of the time, auditors would want to work with a tax professional because we talk the same language,” Pinck says. If you worked with a tax preparer in filing your tax return, share the audit notice with him or her.
Some tax software companies offer audit defense for a fee as a kind of insurance policy in case you get audited. If you do, tax professionals may be on retainer to help navigate the system.
Remember that you have rights when you’re being audited by the IRS, Pinck says. A document detailing your rights should be included with the initial contact notice, he says. Those include the right to professional treatment by the IRS auditor and a right to representation. You also have a right to appeal within the IRS and the courts.
Finally, a word to the wise: If the result of an audit is that you owe additional tax to Uncle Sam, it may also impact your state return, Pinck says. The IRS and states have an agreement to share audit results, he adds. Look into amending your state return as soon as possible to limit fees and penalties.
What If I Can’t Pay My Bill After an IRS Audit?
Ignoring an audit or tax bill won’t make it go away. And delaying repayment could result in penalties, interest and other fees.
If you’re struggling to pay taxes owed, remember that there are tax payment relief options on offer. “Any of the remediation programs could be used if there is a tax debt assessed as a result of an audit,” Armstrong says. Those may include an installment agreement, which are monthly payments, or offer in compromise, which lets you settle the debt for less than the full amount owed.
“The only option that may be off the table would be the ability to claim that you are not responsible, since I would think that would have been resolved at the audit or appeals,” Armstrong says.
If you disagree with the audit’s findings, you may request a conference with an IRS manager, according to the IRS. You may also request mediation or file an appeal if enough time remains on the statute of limitations.
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Update 11/05/20: This story was published at an earlier date and has been updated with new information.