No one enjoys getting a letter in the mail from the Internal Revenue Service (IRS). But how much worse would it be if that letter said the IRS was starting an audit of your tax return?
The word “audit”, alone, is enough to make anyone nervous. Out of the nearly 155 million individual tax returns fled for 2019, only 771,095 taxpayers were audited. This is less than half a percent. While the chances of being audited are low, they are never zero. If one finds themselves in a position of being audited, having all of your documentation in order is key to a quick, easy, and painless process.
For some individuals who typically lean towards “shadier” tax practices, their chance of being audited is significantly higher. The IRS has various red fags that might trigger an audit, but more on that later.
Preparation is the best defense. For an individual, to understand what the time frame is for the IRS to audit, the red fags that might increase their chances of an audit, and knowing who to call in the case of an audit, can be a significant advantage.
What is an IRS tax audit?
An IRS tax audit is an examination of an individual’s or business’, financial records to verify their tax return information is complete and accurate. The IRS conducts audits either through mail correspondence or in-person field audits.
The majority of audits are correspondence audits, which the taxpayer can handle themselves. A correspondence audit is when the IRS contacts a taxpayer through mail to request additional information or documentation to support items on their tax return. These audits can be completed by responding to the IRS request for documents through mail.
In-person audits are field audits that require the taxpayer to meet with an IRS agent at their place of business or residence. If a taxpayer is selected for an in-person audit, they must provide documentation to support their tax return claims. The auditor will also verify this information by comparing it to third-party information sources.
What is the purpose of IRS audits?
The goal of an audit is to ensure that the taxpayer has reported their income, deductions, and credits accurately. The IRS will also review how much tax was withheld from wages, payments, and pensions. If the IRS finds that more tax should have been withheld, they will assess additional taxes, penalties, and interest.
Why does the IRS decide to audit?
The IRS selects returns for audits based on a number of factors. The two primary selection criteria are:
- Taxpayer noncompliance with the tax code
- Random selection
The IRS may select a return for audit if they believe the taxpayer has not complied with the tax code. This can be due to a number of reasons, such as:
- Failing to report all income
- Claiming false or excessive deductions
- Failing to file a return
- Underreporting income
- Making mathematical errors
The IRS may also randomly select a return for audit. This is typically how correspondence audits are conducted. However, the IRS may also conduct field audits on a random basis.
Red flags that could trigger an audit
There are numerous red fags that could trigger an audit by the IRS. While some of these factors are out of the control of the taxpayer, others can be avoided. The most common red fags that trigger an IRS audit are:
- Failing to report all taxable income (including foreign income)
- Claiming false or excessive deductions
- Filing a return with errors
- Odd or inflated bank deposits
- Cash businesses with no income reported
- Businesses with no paper trail
- High-income taxpayers
Timeframe for an audit
Many people assume that the IRS can audit their tax return any time they want, but that’s not actually true. The IRS has a limited window in which they can open an audit, and that window varies depending on the type of audit.
Audit statute of limitations
The statute of limitations is the timeframe in which the IRS can audit a tax return. The timeframe depends on how the return was fled and whether the taxpayer owes taxes.
Still… how far back can the IRS audit go when auditing an individual’s tax situation? It turns out that, depending on circumstances, the agency can look back three years, six years, or indefinitely — all the way back to the beginning of your history as a taxpayer.
If a taxpayer files a return on time and owes taxes, the IRS has three years to audit the return. If a taxpayer files a return late and owes taxes, the IRS has six years to audit the return. If a taxpayer files a return late and does not owe taxes, there is no statute of limitations.
If a taxpayer files a fraudulent return, the statute of limitations is unlimited.
The IRS can audit any valid tax return filed within the last three years
The first thing to understand is that the IRS has three years from the date your tax return was fled to initiate an audit. So, if you fled your 2019 tax return on April 15, 2020, the IRS would have until April 15, 2023, to contact you about an audit.
Two important exceptions to this rule
The first exception is if you fail to report income that should have been included on your tax return. In this case, the IRS has six years from the date the tax return was fled to initiate an audit. So, if you earned income in 2018 that you didn’t report, the IRS could audit your return up to six years after the date you fled it.
The second exception is if you claimed a deduction or credit on your tax return that you shouldn’t have. In this case, the IRS has three years from the date the tax return was fled to initiate an audit. So, if you claimed a deduction or credit in 2018 that you weren’t entitled to, the IRS could audit your return up to three years after the date you fled it.
It’s important to note that these exceptions only apply if the IRS believes that you intentionally omitted income or improperly claimed a deduction or credit.
Statute of limitations on collections
The statute of limitations on collections is the timeframe in which the IRS can attempt to collect taxes that are owed. The statute of limitations is 10 years, but it can be shortened or extended depending on the circumstances. The time that the IRS has to assess a tax liability should not be confused with the time it has to collect on tax liability.
Generally, the IRS has 10 years from the date a tax return was fled to attempt to collect taxes that are owed. However, there are several circumstances that can shorten or extend the statute of limitations.
For example, if a taxpayer files for bankruptcy, the statute of limitations is suspended until the bankruptcy is discharged. Additionally, if a taxpayer leaves the country, the statute of limitations is extended until the taxpayer returns to the United States.
If you haven’t paid taxes or feel as though you have underpaid taxes, it is best to keep track of all of your records from the past 10 years. In the case of an IRS audit, it is best to have these documents handy:
- Receipts relating to your assets.
- All tax records (both electronic and hard copy)
- Proof of when your taxes were fled
Have you been audited in the past?
If you’ve been audited in the past, that could also increase the chances of being audited again. The IRS has a program called the Audit Recurrence Program, which targets taxpayers who have been audited in the past.
Understanding the audit recurrence program
The Audit Recurrence Program uses a scoring system to select taxpayers for audit. The scoring system takes into account factors like how many times you’ve been audited, how much tax you owe, and whether you file your taxes on time.
So, if you’ve been audited in the past, that could increase the chances of being audited again. However, it’s important to note that just because you’re in the Audit Recurrence Program doesn’t mean you will definitely be audited.
How far back can the IRS audit? Let’s take a deeper look.
Three-year IRS audit
Most often IRS tax audits look back three years. The three-year audit covers the tax year in question and the two years preceding it. The IRS will pull all the pertinent information from these years to conduct a comprehensive review.
Generally, the IRS looks for discrepancies within your tax returns during an audit. This could be something as simple as claiming too many deductions or errors on your return.
If you forget to file or file late, the three-year window goes back to the due date, not the actual tax fling date. However, if you file for an extension, then the audit period goes based on the later due date (typically 6 months later).
Six-year IRS audit
Even without criminal activity or fraud, the IRS can choose to look back six years. The most common reason for a six-year audit is when the IRS believes there’s a “substantial omission of items.”
This means that you left off more than 25% of your income, which the IRS considers being a pretty big deal. If this happens, the agency can decide to look at your tax returns from up to six years ago to see if you’ve been consistently underreporting your income.
Additional income from investments, gifts, inheritances, and other assets are important details to report on your taxes. Although this is an essential step, the IRS can still select to audit you. However, if all the proper forms are completed and submitted, it can greatly decrease your chances of a six-year audit. Working with a tax attorney can help ensure you have completed all the necessary steps.
Ten-year IRS audit
There are very specific circumstances in which the IRS can look back at your tax returns for up to 10 years. These circumstances generally involve instances of fraud or criminal activity.
For example, the IRS might decide to look back 10 years if they believe you’ve been filing false tax returns or engaging in tax evasion. Additionally, in criminal tax matters, the statute of limitations will be tolled by one’s fugitive status.
If you’re being audited and the IRS believes that you’ve committed fraud, they will likely notify you of their intention to look back 10 years. If this happens, it’s critical to seek out the help of an experienced tax attorney.
Indefinite IRS audit
A tax audit with no time limit placed on how far back they can audit is a special case. What circumstance might prompt a tax audit dating back indefinitely?
- No tax return has ever been filed
- Omit tax forms or fail to report any gifts or foreign income
- Commit tax evasion or tax fraud
The IRS can find out any time you receive income, whether it is inside the United States or not. This is because the IRS has what is called the Foreign Account Tax Compliance Act.
The act requires any U.S. citizens or residents with foreign accounts to report them to the IRS. If you don’t comply, then you could face an audit that stretches back indefinitely.
When examining how far back can the IRS audit, it is important to remember it is based on specific circumstances.