What Happens When You Get Audited by the IRS?
Ready to file and forget your taxes? By the time April 15 rolls around, most of us are, but if you’re one of the unfortunate folks who got flagged for a tax audit, you’ll have a few more hoops to jump through with the Internal Revenue Service (IRS) this year.
We take a look at what a tax audit is and why it can happen to you. We’ll also explain how the audit process works and common (and less common) ways your audit can be resolved.
Read on to learn more.
Why Me and What Happens If I Get Audited by the IRS?
Finding out that the IRS plans to audit your personal or business tax return is always an unpleasant surprise. Understanding what an audit entails can help reduce worries and prepare you for what's ahead.
In a simple explanation, a tax audit is a further review of your tax return and records to ensure that your income, credits, and deductions have all been properly reported according to tax laws. It does not necessarily mean you are at fault or have committed a crime.
While the IRS will flag tax returns with missing information or discrepancies, it also selects those with business dealing with a suspicious business or person, while a certain number are selected for review at random.
What happens next? Let’s start by taking a closer look at how your audit will work.
How Do IRS Audits Work?
Here’s how an audit is initiated, conducted, and (in most cases) resolved.
Initiating an Audit
A tax audit starts when something in your return catches the attention of the IRS. These days the IRS uses sophisticated algorithms and statistical techniques to model how returns “should” look and compares actual returns to these, while also manually inspecting returns.
If these systems flag your return—or important information is missing—you’ll be notified by mail—never phone, email, or text. This is to ensure every stage of the audit is documented and to prevent you from being targeted by fraudsters pretending to be the IRS.
The Audit Process
Depending on the discrepancy in your review or the complexity of your return, audits will be conducted via mail or in-person interview.
By-mail audits are most common for straightforward issues such as errors in completing your return or to check that you have documentation for a deduction you have claimed. You’ll receive official correspondence asking you to provide the documentation or clarify your returns.
For more involved audits, you’ll need to attend a meeting at a local IRS office or IRS staff may visit you. These usually involve “high-net-worth” individuals with complex investments or business tax audits, but you are always free to visit your IRS office to resolve an issue.
Most audits involve requests for specific documents. These can include:
Detailed itemized deductions
Expense receipts
Bank and investment account statements
Transaction records.
While audits feel intrusive, just remember that the goal is to check that your return is accurate. The process will be much smoother if you have your expense and tax records organized in advance and easily accessible.
If you have underpaid taxes by a significant amount, auditors will be on the lookout for evidence that you intended to defraud the IRS by underpaying or delaying your taxes. While you most likely did nothing wrong, it’s important to be cooperative and transparent to prevent giving any impression of wrongdoing.
Five Common Reasons Why the IRS May Audit You
Very few of us are criminal masterminds looking to defraud the U.S. government out of millions of dollars in unpaid taxes. Here are the most likely reasons the IRS may flag your return for audit.
Math Errors: Double-check your addition whenever you need to add up a column of figures. IRS reviewers and electronic systems are trained to spot simple math mistakes.
Underreporting Income: You might have honestly forgotten to report some income, but the IRS can cross-reference records with your employer or client. Be sure to report all earnings including freelance or “gig” work, side hustles, rent, gifts, and investments.
Inaccurate Charitable Donation Claims: Make sure you have the proper documentation when claiming significant charitable deductions. The IRS will be wary of money spent on even the worthiest of causes.
Excessive Business Expenses: Self-employed taxpayers can deduct a wide range of business expenses, but don’t get carried away. Large claims, especially for travel, accommodation, entertainment, or catering services will attract attention.
Home Office Deduction: Yes, deductions for home offices are allowed and are common as more people work from their residences these days. But your home office space needs to be accurately and honestly reported and must be used regularly and exclusively for business.
If in doubt about a deduction, consult a qualified tax expert. It’s money well spent on ensuring your return does not attract unwanted attention.
Audit Results: 4 Possible Outcomes
Once you’ve submitted documents, answered questions, or allowed the IRS to inspect your records, your audit can result in one of four outcomes.
1. Your Return Is Approved as Filed
Ideally, the additional information or clarifications you provide result in the IRS accepting your tax return without any changes—meaning you've passed the audit with flying colors. Your financial records and tax filings are in good order and you’ll receive any refund you are due.
2. Corrections and Additional Taxes
More often, an audit uncovers discrepancies that your additional filings do not entirely justify, meaning that adjustments will be made to your tax return. In most cases, these changes boil down to you having to pay more taxes.
The IRS will guide you through the steps you need to take to remedy the situation and avoid further penalties. If you need to pay off your taxes or back taxes over time, the IRS will sign you up for a payment plan but will charge interest on the tax money you still owe.
3. Penalties
Where serious discrepancies are found during your audit, the IRS can levy penalties over and above the tax money you owe. Typically, these penalties can be:
20% of the portion of the underpayment of tax that happened because of negligence or disregard for tax rules or regulations
40% for “gross misstatements” of taxes due, for instance by understating the value of properties or estate taxes
Keep in mind that you have the right to appeal IRS audit findings and even to take the IRS to court if you feel you have been treated unjustly.
4. Extreme Cases
In some instances, the IRS may decide to pursue further penalties through legal action or even by filing criminal charges. In cases like this, courts may award very large fines, especially in big corporate cases, and may suspend your business license or even order jail time.
Outcomes like this are very rare and are usually the result of a systematic attempt to deceive the IRS to avoid or delay taxation.
Tax Audits: 5 Frequently Asked Questions
We answer a few of the most common questions about tax audits:
How Long Will the Audit Take?
How long it takes to resolve an IRS audit depends on its complexity including the type of audit, how easy it is to find requested documentation, and whether or not you dispute the findings. Simple corrections can be wrapped up in a few months. Big corporate cases drag on for years.
What Is the IRS Audit Statute of Limitations?
The IRS usually takes three years from the date your tax return is filed to carry out any audits and levy any additional assessments. However, there are exceptions to this law including if you have been found to have understated a large amount of income or deliberately failed to file. In these cases, the IRS can extend its reach to six years. For serious fraud, there is no limitation.
Can I Appeal an Audit Decision?
You have the right to appeal an IRS audit’s findings. Appeals must be filed with the office that sent you your audit decision. The office will try to resolve your request through a conference with your auditor’s manager or a mediation hearing. If this fails, they will forward your case to the IRS Office of Appeals.
Should I Have a Tax Professional Represent Me During an Audit?
For more complex or disputed cases, having a tax professional such as a certified public accountant (CPA) or tax attorney can be very helpful. These tax experts provide a more thorough understanding of how tax law applies to your specific case.
What Is the Taxpayer’s Bill of Rights?
The Taxpayer’s Bill of Rights lays out 10 fundamental rights every taxpayer has when dealing with the IRS. These rights help ensure taxpayers receive due process when being audited, including the right to be informed and the right to challenge the IRS's findings.
Listerhill: Tax Compliance Finances You Can Trust
Tax law is very complex and this blog provides only a general overview of the Internal Revenue Services’ audit process. For expert guidance, it’s important to talk to your CPA or a tax lawyer.
The best way to handle an IRS tax audit is to avoid it. You can do this by keeping good records and avoiding hard-to-trace investments or transactions.
Please reach out to a Member Advocate for help with accounts that might help you take advantage of tax savings and protect your personal or business finances from the risk and uncertainty of an IRS tax audit. with solid advice and quality, tax-compliant financial products.
