You may picture a tax audit like a scene in the movies: IRS agents in dark suits show up at your door and sift through boxes of papers.
Instead, most tax audits are much less dramatic. They usually start with a letter, and in most cases the IRS handles them entirely through correspondence.
Here’s what actually happens during a tax audit — and what you can do to help the process go as smoothly as possible.
What Is a Tax Audit?
“A real audit starts with the fact that the IRS computer has identified a difference in the average percentage of write-offs on the return,” Marc Dombrowski, enrolled agent in Hamburg, New York, says.
The IRS computer system compares your tax return with “norms” for similar returns. Then, the IRS audits those returns that stand out.
[Read: Tax Write-Offs You Shouldn’t Overlook.]
“There are different programs that the IRS has for determining which returns to audit,” Michelle Marion, managing director, Washington National Tax, KPMG LLP, says.
“Individual returns are often selected based upon scoring within the IRS system. Returns are scored through this computer scoring program, and the system will label a return with a high score, suggesting that there may be some issues that would lead to adjustments,” she adds.
Receiving an audit notice doesn’t necessarily mean the IRS thinks you made a mistake; it’s just that the information in your return stands out and they want more information.
“The program is populated by the IRS’ experience,” Marion says.
“So, it doesn’t mean anything with that particular return, as much as it says something about this is the general experience that they’ve had with the returns that report something similar. It will get a high score if the system determines that the return is more likely to have issues but it doesn’t mean that the return has issues,” she says.
Some Triggers That Cause Audits
If you have any self-employed or other business income, having much lower profit ratios than other similar businesses could lead to an audit, Dombrowski says.
[READ: A Guide to Tax Deductions for the Self-Employed]
“The No. 1 way to get audited is by having an unusual ratio in your profit. This is based on your industry,” he says.
He also says the IRS has different expected profit ratios based on the business code you reported on your return. You may just need to prove that your expenses were legitimate if yours is different from the norm.
“If you have all your receipts and all of your legitimate expense receipts proven, you have nothing to worry about if you get audited, even if you happen to have a significant amount of expenses as a ratio,” Dobrowski says.
You might also be audited if the itemized deductions you claim are much higher than most people with similar returns.
“If you itemize nowadays and have a significant amount of charity or gambling or medical write-offs, you have a much better chance of getting caught up in this type of audit,” he says.
In addition, the IRS may conduct an audit asking for more information about credits you claimed, such as the number of children you included in your earned income tax credit calculation.
There are also certain triggers they look for on returns, such as entities that don’t show any owner wages or having just enough income from a side hustle to qualify for certain tax credits, or even income and expenses that don’t make sense for the business code reported, Chelsea Monk, EA and client manager with Hamilton Tax and Accounting in Grayslake, Illinois, says.
Not All IRS Notices Are Audits
After you file your return, the IRS computer system screens it for errors and sends you a notice if something doesn’t add up. Not all notices from the IRS, however, are audits.
For example, if you made a math error on your return, the IRS may correct it and send you a notice adjusting your refund or tax owed from the amount on your return.
If you agree with the adjustment, you don’t need to do anything other than pay any additional money you owe. If you disagree, the notice will state the deadline and steps for disputing the adjustment.
The IRS also uses an automated system that compares the items you report on your return with information financial institutions and employers report. For example, financial institutions report things like taxable dividend, interest income and capital gains, while employers report income via W-2s and 1099s.
“The matching of income documents against someone’s filed tax return is all done by computers,” Dombrowski says.
If any of those items don’t match up, you may receive a CP2000 Notice from the IRS, explaining how the numbers on your return differ from the those third parties reported; it also proposes changes to your income, tax, credits or payments.
“This is not an audit,” Dombrowski says.
Again: If you agree, you sign the response form and send it in with any money you owe. If you don’t, complete the form, provide a signed statement explaining why and send documents supporting your statement. Make sure you meet the deadline specified in the notice.
If the information from the third party was incorrect, you may need to contact the employer or financial institution to correct it.
For more information about your taxpayer rights, see the IRS Tax Return Reviews by Mail publication.
Audit Limitations
The IRS generally has up to three years after you file to audit a return but the time frame can be longer — typically up to six years — if it finds a substantial error.
You’ll generally hear from the IRS much earlier, however.
“Most returns are selected for examination within the first 24 months of filing,” Marion says.
“If you’re 2 1/2 years from the date of filing, the chances of an audit go down,” she adds.
The odds are low that you’ll be audited: As of May 2022, the IRS had audited only 0.2% of taxpayers with 2019 income of $25,000 to $500,000.
Even taxpayers earning from $500,000 to $1 million had just a 0.6% audit rate. The audit rates are higher for people at lower and higher income levels, and they may increase with extra IRS funding from the Inflation Reduction Act, some of which the organization used to hire more more enforcement agents.
What Happens if You’re Audited
If you’re scheduled for an audit, the IRS will send you a letter stating that your return for a specific tax year has been selected for examination and specify what it would like to review and verify, Marion says.
“The IRS conducts a lot of audits of individuals through ‘correspondence examinations,’ which typically concern less complex return issues,” she says.
“With a correspondence examination, the initial letter from the IRS is computer-generated and identifies the items that are being reviewed, such as the earned income tax credit or the taxpayer’s filing status, and requests that the taxpayer provide documentation to support those items by a specified date,” she adds.
[READ: How to Choose Your Tax Filing Status.]
“It can be as simple as a substantiation of a deduction or perhaps income related,” Morris Armstrong, EA in Cheshire, Connecticut says. “The auditor will include an IDR — Information Documentation Request — listing what they want back from you.”
For more complex return issues, you may be assigned a specific auditor in the beginning — and they may set up an opening conference to discuss what they’re looking for.
“It’s an opportunity to meet, usually on the phone, with the auditor and discuss procedure,” Marion says.
In addition to requesting certain documents, they may also talk about what the audit means, what your rights are and how to appeal the decision if you disagree with it, she says.
How to Respond to an Audit Notice
The audit notice gives you a deadline for providing the requested documents. After you send them in, the IRS will determine whether or not the evidence is sufficient to support the item at issue, Marion says.
“If they have other questions they would ask for additional records or information from the taxpayer to support the item that is being audited,” she says.
Steps That Can Help You Make it Through a Tax Audit
Now that you know what to expect from an IRS audit, take these four steps to help you get through one:
1. Keep the Right Records
The most important step happens long before you hear from the IRS: When you’re filing your return, gather the appropriate records so you’re ready in case you are audited.
“As far as steps people can take for an audit, being organized is the No. 1 thing that helps,” Dombrowski says. “Have your expenses organized by category as you had taken them on your tax return. Remember that for each expense you must have both the invoice for it as well as proof of payment.”
Just having a check you wrote to an insurance or utility company doesn’t prove you paid for a business activity, he says. If you wrote off your business insurance as a business expense, for example, keep the insurance company bill and a copy of your check or other payment.
2. Meet Deadlines
Whether you’re sending the documents yourself or getting help from an EA, certified public accountant or other authorized professional, make sure you send in the information the IRS requests within the specified time frame.
“It is very important to provide organized and timely responses to the IRS in those examinations,” Marion says. “By meeting deadlines and laying out information in a clear fashion that’s your opportunity to gain creditability.”
3. Answer Only Specific Questions
Marion recommends answering only the questions the IRS asks.
“If you get a request from the IRS for information, I wouldn’t be providing more information than is necessary to answer that question,” she says. “The more information you give, even if unsolicited, then you’ve basically potentially broadened the scope of the examination. Try to narrow the response to any questions.”
Read the notice carefully to find out what it is the IRS is questioning. You can look up more information by inputting your notice number on the Taxpayer Advocate Service website.
4. Know When to Get Help
If a CPA or EA filed your tax return, contact them immediately if you receive an IRS examination letter.
If you filed your own return you may be able to respond to a simple document request yourself but you may want to contact a CPA or EA for help, especially if you have questions.
You can find EAs in your area through the National Association of Enrolled Agents website and CPAs via the IRS Search for Tax Return Preparers tool. Or, you may qualify to get help from a low income taxpayer clinic. You can locate one near you by visiting the IRS Low Income Taxpayer Clinic List.
“The best thing that an enrolled agent can do for you during an audit is give you the ear and expertise of someone who knows the process and can be the intermediary between you and the IRS,” Monk says.
“People get nervous when speaking to the government and tend to ‘overshare’ and confuse matters. If you’re working with an EA, you can tell them what’s going on and they’ll tell you what documentation they need from you. Then when they’re speaking with the auditor, they have the experience and expertise to only share what’s necessary for the audit,” he says.
An EA, CPA or other authorized professional has experience knowing what the IRS is looking to resolve.
“Some of the feedback we’ve gotten from clients is that we’ve helped them stay calm during what was an otherwise stressful time,” Monk says. “We’ve had business owners being threatened with a six-figure tax bill that we managed to wipe out because we knew what documentation they needed to provide to prove their case.”
For more information about audits and IRS notices, visit the Taxpayer Advocate Service website, which explains notices you may receive and your rights.
The TAS also offers a roadmap explaining what happens to a tax return, beginning with processing and screening through examination, appeals and litigation. Another helpful resource is IRS Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund.
What Happens Next?
Audits typically last for three to six months, depending on the complexity, Dombrowski says. After you send in the documents, the IRS may close the investigation.
“There are a lot of examinations that are opened and then closed as no changes,” Marion says. “An auditor comes in and verifies that the specific items on the return look correct and they close the examination without making any adjustment.”
Or, the IRS may request more information or send a notice proposing changes to your tax return. If you agree with the changes, sign the letter and send any additional money you owe. If you disagree, the notice will explain your rights to appeal, what steps to take and the deadlines you must meet.
This letter gives the taxpayer the opportunity to request an appeal to an independent body within the IRS, which will take a fresh look at the issue, Marion says. You can represent yourself, or an EA, CPA, attorney or other federally authorized practitioner can represent you in the appeal.
If you’re not happy with the result of the appeal, you may be able to take the issue to the next level.
“If the taxpayer is not satisfied with the settlement offered with appeals, then they can go to U.S. Tax Court,” Marion says.
You’ll receive a notice with your rights, the requirements for taking the case to Tax Court and the deadlines for doing it. An attorney or United States Tax Court Practitioner can represent you in Tax Court.
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What Really Happens During an IRS Tax Audit originally appeared on usnews.com
