If you receive an audit notification from the IRS, don’t panic! While no one would call an audit fun, it does not have to be the stuff of nightmares, either. As with most things, the better prepared you are, the easier the process will be.
What Exactly is an IRS audit?
According to the Internal Revenue Service, an audit is an examination of an individual or organization’s accounts and financial information. The goal of the audit is to make sure that your prior tax returns were accurate and in compliance with federal tax laws.
Typically, the auditor will request documents to compare with the information on your tax returns. They may ask for receipts, bills, and canceled checks to show your expenses. In addition, any legal paperwork, such as that relating to a divorce, civil or criminal trial, or a loan is fair game. Sometimes, the auditor may even ask for less formal documentation, such as a travel log or a statement from your physician or employer.
As with most things, being organized will help you immensely. If you do not currently have a system for keeping track of these types of records, you should consider creating one immediately. The audit process will be much easier if you are not frantically trying to locate all the necessary information. The IRS will accept some documents electronically, but hard copies are always acceptable.
In some audits, the documentation you provide will give the auditor enough information to reach a conclusion. However, that is not always the case. Oftentimes, the auditor will want to meet with you for an in-person interview. They may also want to speak with your employer, tax-preparer, or even your doctor. In some cases, the auditor may send a written questionnaire, rather than conducting an interview.
Under Federal Tax Laws, the general rule is that audits can only go back 3 years from the current tax return. However, the vast majority of audits fall under one of the numerous exceptions to this rule. These exceptions allow an auditor to look back 6 years.
A typical audit will take around 3 to 6 months to complete. However, the duration can vary widely. Obviously, the faster you provide documentation, the better. Other timeline factors include the complexity of the issues, and the availability of people the auditor needs to talk to.
Everyone’s financial situation is unique, but some fit better than others into the standard boxes and forms. The IRS utilizes Audit Techniques Guides when examining information relating to certain situations and industries. There are currently 50 guides, covering issues like tax credits, income from lawsuits, and stock-based compensation. There are also guides that deal with specific professions, such as clergy, entertainment, and retail.
In the simplest terms, the auditor will reach one of two conclusions. Either your tax returns were accurate, with no changes needed, or they weren’t. Of course, the latter conclusion can result in a wide range of consequences. You may only simply have to pay the correct amount. Still, in some cases, the IRS will assess an accuracy penalty, typically 20-40%, on top of that amount. However, in cases of intentional underpayment, the IRS can charge a civil fraud penalty of 75%. If your actions rise to the level of a criminal offense, the IRS may request prosecution through the U.S. Department of Justice Tax Division. Fortunately, this is rare, with fewer than 2% of audits resulting in criminal charges. It’s also possible that the audit will show that you overpaid your taxes. In that case, you will typically receive a refund, often with interest.
Once the auditor determines that you underpaid your taxes, they must figure out why. Did you intentionally under-report your income or property values? Did you ignore IRS rules and regulations?
Another possibility is reasonable cause. This is generally a situation where you made an error in a good faith effort to pay your taxes correctly, but underpaid due to said error. There are several ways this can happen:
- Reasonable misunderstanding of tax laws due to education and experience
- Isolated calculation or transcription errors
- Reliance on erroneous information or advice, such as an incorrect W-2 or incorrect advice from your tax-preparer
If you can show the auditor that your error was due to reasonable cause, you may be able to avoid a penalty. However, you will still have to pay the corrected tax amount.
What do you do if you disagree with the auditor’s conclusions? One option is to request a meeting with an IRS manager. They can review the auditor’s work and may catch any obvious errors. Another option is to utilize the IRS Mediation Program. This voluntary, non-binding process can help quickly resolve minor issues while your audit is still in progress. After the audit is complete, you have the right to appeal. Typically, the first step is to request an appeal through the IRS Independent Office of Appeals within 30 days of the audit conclusion. You also have the option to file a lawsuit in U.S Tax Court.
Your Rights Surrounding an Audit
While cooperation with an audit is mandatory, you do have rights as a taxpayer. You have the right to professional and courteous treatment throughout the process. In addition, your tax information is private, so the auditor must follow confidentiality rules. Furthermore, and most importantly, you have the right to representation. It is imperative that you have help from someone who has at least as much knowledge and experience as the auditor. An attorney who specializes in tax law will be invaluable, both during the audit process and during any appeals.
Your best plan for dealing with an audit is to avoid the process altogether. Tax laws are complicated, and it is all too easy to make a mistake. There are also some common red flags that you should avoid to decrease your chances of an audit. File your taxes on time, and proofread them carefully. Common errors in math or even forgetting to sign your tax return can trigger an audit. Also, resist the temptation to overreport deductions or underreport income. The best prevention and defense for an audit is to be completely honest on your tax return.
When it comes to audits, it’s best to engage the services of a qualified professional to help you file your taxes. Submit a request online or call us today at (866) 345-6784 to get in touch with an attorney in your area!