Taxpayer Guide to IRS Tax Audits

tax audits

The word “audit” strikes fear into most taxpayers’ hearts, but are they really that bad? Well, it depends on the situation. If the IRS only requests a bit of information and you have well-organized records, you may be able to get through the process fast and easily. A full-scale audit of every detail on your return, especially when coupled with poor recordkeeping can be a nightmare. 

Luckily, there are attorneys who provide audit representation. To get help now, contact us at Seattle Legal Services today. In the meantime, here’s an overview of audit basics and tips.

What Is an IRS Audit?

An IRS tax audit is when the IRS reviews the information on your tax return and asks you to back it up. When you file a tax return, you don’t include sporting documents such as W2s, 1099s, profit and losses from your business, etc. If the IRS selects your return for an audit, the agency will want to see these types of documents to verify the information on your return. 

The agency will also assess your eligibility for claiming credits and deductions as well as other information on your return. The information the agency requests will vary based on the claim. For example, the IRS may ask for details to support your Head of Household filing status of your Child Tax Credit claims. 

There are several different types of audits, and they take a range of scopes, with some only looking at a few details on your return and others taking an exhaustive approach.

Types of Audits

Here are the main types of audits. Note that some of these categories can overlap:

  • Correspondence audit – The IRS requests all audit documents through the mail, and you don’t have to meet with the auditor in person.
  • Office audit – You meet with the auditor in their IRS office.
  • Field audit – The IRS auditor meets with you in the “field”, typically your place of business or your tax attorney’s office.
  • Automated Underreporter Program – IRS computers check the information on your return against forms submitted by other people and flag your return for audit if it sees discrepancies.
  • Employment tax audit – The IRS audits your employer tax returns, such as 941 Forms.
  • ERC audits – The IRS looks at the employer retention forms reported on your employer payroll tax returns.

The IRS may audit any return that you submit to the agency. If you have been selected for an audit, the agency will contact you by mail. Keep your address updated with the IRS so that you don’t miss notices. 

Types of Penalties with Audits

If the auditor disagrees with the information on your return, then, you effectively “fail” the audit. The auditor will send you a notice of the proposed changes on your return. If you don’t agree, you have the chance to appeal, but only if you respond within 30 days. 

When auditors make changes that increase your tax liability, they may also assess the following penalties. 

  • Failure to pay and failure to file penalties – These penalties are respectively 0.5% and 5% of your unpaid tax per month. The IRS may backdate these penalties if you owe additional tax after an audit.
  • Accuracy-related penalty – If you understate your income by a significant amount, the IRS can apply an accuracy-related penalty of 20% of the unpaid tax. 
  • Fraud penalties – Fraud penalties are 75% of the underreported tax. For instance, if the audit increases your tax liability by $20,000 and believes the discrepancy is related to fraud, the penalty can be $15,000.

Common Audit Notices

If the IRS selects you for an audit, you may receive the following notices as well as others:

  • Letter 566 – Initial contact letter letting you know you’ve been selected for an audit.
  • CP2000 – The IRS is changing your return based on information received from other parties.
  • CP75 – The IRS is auditing the Earned Income Credit (ERC) on your tax return.
  • Notice 4549 – Summary of the proposed changes to your tax return.
  • Form 4564 – Information Document Request, which outlines the information the IRS auditor wants from you.

What If You Get Audited and Don’t Have Receipts?

The information you need to provide varies based on the scope of the audit. If you don’t have the records that the IRS needs, consult with a tax attorney about reconstructing your records. You may also be able to rebuild records using bank statements, cell phone records, calendars, correspondence, and other documents.

Audit Red Flags – How to Protect Yourself From an Audit

The IRS can randomly select any return for an audit. You shouldn’t worry about red flags. Instead, you should complete an accurate return and you should save your supporting documents for at least three years. Then, if you are selected for an audit, you should generally be able to pass it. 

So-called red flags include self-employment income, the Earned Income Tax Credit, unusual business deductions, low income for your area, reporting no income, reporting over $1 million in income, home office deductions, and large charitable contributions.

However, in the right situation, many of these “red flags” are completely legitimate. Don’t get scared about claiming a legitimate credit or deduction, if you’re entitled to claim it. Problems generally only arise if you claim a credit or deduction erroneously, or if you inaccurately report your income. 

For example, if you claim the home office deduction and you are selected for an audit, the deduction will be fine as long as you are truly entitled to take it. Conversely, if you’re not entitled to take that deduction, the IRS auditor will remove it from your return and potentially assess penalties against you.

How Far Back Can the IRS Go for Audits?

You generally only have to worry about the IRS going back three years. But in cases of fraud, the IRS can go back six years. Sometimes, the agency extends the audit deadlines – for example, the IRS has extended the audit statute of limitations on certain payroll tax returns with Employee Retention Credits.

The Audit Reconsideration Process

As indicated above, audit results aren’t final right away. If you disagree with the audit results, have new information to share, or missed the audit meetings, you can request reconsideration. Make sure to request reconsideration by the deadline on the notice. Consider getting a tax attorney with audit experience to help you with this part of the process. 

When to Hire a Tax Audit Attorney

Ideally, you should hire a tax attorney as soon as you get an audit notification from the IRS. However, if it’s just a basic correspondence audit and you have the records, you may want to deal with the situation on your own. 

If you’re dealing with confusing or overwhelming requests for records, it may be easier to work with an attorney. You should also consider representation in cases where the auditor disagrees with your interpretation of the tax law or if you want help appealing audit results. To get help now, contact us at Seattle Legal Services today.