What Happens if the IRS Audits You? 

If the IRS audits you, it means they want you to verify information you provided on a tax return. It doesn’t necessarily mean the IRS is trying to collect unpaid taxes from you. If they were, the IRS would send you an unpaid tax notice, such as a CP14 or LT19. 

Despite these differences, it’s sometimes easy to misunderstand a letter from the IRS, especially regarding an audit. The goal of this article is to discuss the different types of audits, what to expect during an audit, and how to respond when learning the IRS wants to audit you. To get audit representation now, contact us at Damien’s Law today.

Key Takeaways 

• The IRS uses audits to verify information provided on a tax return.
• Audits can be conducted by mail (correspondence audits) or in person (office or field audits).
• The audit process involves the IRS asking for documents to support information on a tax return, and the taxpayer providing that documentation.
• Failing to provide the documents won’t automatically result in a failed audit, but it makes the audit more difficult to get through and increases the chances of failing the audit.
• If you disagree with the audit’s results, you can ask for a review by talking to an IRS manager, requesting mediation, asking for audit reconsideration-, or filing an appeal. 

What Is (and Isn’t) an IRS Audit

The IRS may want to audit you if it finds a possible issue, indicating there could be an error with your tax return. Because of this potential error (whether accidental or deliberate), the IRS wants you to provide further information.

One thing to keep in mind is that an audit notice is not the same as a correction notice, such as CP2000 (although this can sometimes serve as notice of an audit). A correction notice usually gets sent when the IRS is already pretty sure there was a mistake with your tax return, and the IRS is letting you know how they plan to correct it.

If you agree with the proposed tax adjustments contained in the correction notice, you don’t typically have to do anything beyond pay the tax balance. If you disagree, then you’ll need to provide additional information to the IRS to explain why. This disagreement can effectively turn a correction notice into an audit notice (more on this later). 

Types of IRS Audits 

There are three types of IRS audits:

• Correspondence audits
• Office audits
• Field audits

Most IRS audits are correspondence audits and take place by mail. They begin with the IRS sending a letter asking for additional information about one or more items on a tax return. This might include documents to verify claimed deductions, for instance.

An office audit is an in-person interview that takes place at an IRS office. A field audit is also an in-person interview, but is held at the taxpayer’s home or place of business. In-person interviews often occur because the amount of documents the IRS wants to review is too extensive to be sent by mail at a reasonable cost. 

Why the IRS Chose to Audit You 

Being chosen for an audit doesn’t automatically mean you did something wrong or that there’s a problem with your tax return. The majority of audit decisions are made by a computer.

The IRS has an automated system called the Dependent Database (DDB) program. This system reviews tax returns for potential “red flags” that might indicate tax noncompliance. There’s also the Discriminant Function System (DIF), where the IRS compares a particular return to a random sampling of returns to see if the return in question stands out in some way. If so, it could result in an audit.

Exactly how these automated systems work is not public knowledge (or easily understood). But there are certain types of taxpayers or reported tax information that make it more likely that a particular tax return will be audited. 

Very High and Low Income Taxpayers 

According to a 2023 IRS report (using individual tax return data from 2013 to 2021), lower and higher-income taxpayers were at the greatest risk of getting audited. For example, 0.9% of those with less than $50,000 in reported income were audited. And those with more than $1 million in reported income were audited at a rate of 4.8%. However, those with reported earnings above $50,000 and below $1 million had a combined audit rate of just 0.7%.

One reason why wealthier taxpayers face a higher audit risk is that they’re more likely to use more extreme tax avoidance strategies. Another possible explanation is that wealthier taxpayers have more money for the IRS to potentially collect through tax enforcement activities.

As to why lower-income taxpayers face a higher audit risk is largely due to the earned income tax credit. Only taxpayers who meet certain lower-income thresholds are eligible for this credit, which is often mistakenly claimed. And it’s often mistakenly claimed because the tax law providing this tax credit is complex. 

Self-Employed Taxpayers 

Taxpayers who work for themselves are often at higher risk for audits because they’re more likely to claim deductions incorrectly. Some of these include the following:

• Home office deduction
• Car expense deduction
• Business travel deduction
• Qualified business income deduction
• Depreciation deduction

It’s also easy for a self-employed taxpayer to fudge their income numbers, as there’s no employer to automatically withhold income each pay period. 

Relationship to Other Taxpayers 

There could be nothing on your return that catches the attention of IRS computers, but you could still be chosen for an audit if you’re connected to a taxpayer the IRS has audited. If the IRS audits one of your business partners or investors and finds a problem, it could result in you getting audited as well.

Other Potential Audit Red Flags 

The IRS and its computer systems don’t just look at income level, income sources, or deductions claimed when deciding who to audit. There are other patterns or traits that many audited tax returns share, such as:

• Large charitable deductions in relation to reported income.
• Mathematical errors.
• Estimated deductible expenses (a good example is business costs that always seem to come to a perfectly round number, such as $100.00 for a client dinner or $400.00 for an airline ticket).
• Significant portions of income come from cash sources.
• A business that consistently loses money. 

How to Know the IRS Is Auditing You 

If the IRS decides to audit you, it’ll send you a letter. What they won’t do is call you, text you, or email you to inform you about the audit. If you learn about an “audit” through a form of communication other than Certified Mail, it’s probably a scammer contacting you.

There also isn’t a standard form or letter that the IRS uses for all audit notifications, but getting a certain letter or notice often indicates that you’re not subject to an audit. For instance, CP501 is a notice the IRS uses as a first notice about unpaid taxes. If you receive this notice, you’re probably not being audited.

In contrast, CP2000 only sometimes means you’re being audited. As mentioned earlier, it’s normally used as a correction notice, but it can sometimes result in a correspondence audit. A CP2000 notice can effectively turn into an audit letter if you disagree with the IRS’ proposed tax adjustment and intend to produce documents to support your position.

This is why it’s important to carefully read any notice you receive from the IRS and make sure you fully understand what it says. Whether you agree or disagree can make the difference between a letter basically serving as a tax bill or notifying you of a tax audit. Other letters or notices from the IRS that may indicate you’re being audited include CP75 (this relates to additional information for verifying an Earned Income Credit claim) and Letter 566.

While the number on an IRS letter or notice can give clues as to whether you’re being audited, you need to focus on what the document is saying. Generally speaking, if you receive a document from the IRS via Certified Mail that contains the following information, you’re probably being audited:

• Your name and tax identification number.
• IRS contact information if you want to respond to the letter.
• A number indicating what kind of form, letter, or notice you’re being sent.
• Wording that explains that one of your tax returns has been chosen for an audit.
• What part of the tax return in question the IRS is auditing.
• What documents or additional information the IRS is seeking from you.

If you’re not sure about the legitimacy of a notice or letter you got in the mail, you can always call the IRS at 1-800-829-1040 to ask for confirmation. 

What to Expect During an IRS Audit 

What you can expect depends on the type of audit. If you’re dealing with a correspondence audit, then you can expect the audit to consist largely of an exchange of letters and documents. 

Correspondence Audits 

Let’s say the IRS sends you a notice indicating you had $5,000 in unreported interest income from a bank account and asks that you either acknowledge this unreported income or explain why it doesn’t belong to you.

Let’s also imagine that this isn’t your taxable income, as the bank account that generated the interest never belonged to you. What you might need to do is contact that bank and find out why your name and tax identification number are attached to a bank account that’s not yours.

Assuming there was a mistake on the bank’s part, you could ask the bank to notify the IRS of the error. Whether or not they agree to this, you also want to respond to the IRS notice by explaining the situation and including a copy of a letter or email from the bank acknowledging its mistake. 

Field and Office Audits 

Dealing with a field or office audit will likely be a more involved and complex process. The first step is to confirm the in-person interview and its location provided in the audit letter you just received. If this works for you, go ahead and mark your calendar and get started gathering the necessary documents.

If you need to reschedule the date of the interview or change its location, you can contact the IRS revenue agent handling your case. What happens next can vary widely depending on the tax issue leading to the audit and the information the IRS seeks from you.

If you’re dealing with an in-person audit, it’s strongly recommended that you either hire a tax professional to represent you during the audit or at least consult with a tax pro to get a better understanding of what you’re dealing with and how to properly respond to the IRS.

If you decide to hire someone to represent you, you’ll need to file IRS Form 2848, Power of Attorney and Declaration of Representation. This form officially authorizes someone to represent you before the IRS. This individual must be eligible to practice before the IRS before they can represent you.

In-person audits are often intrusive and usually involve more complex tax issues that concern large amounts of tax information or complicated tax questions that are difficult to explain or communicate by letter. It could potentially involve the IRS revenue agent spending hours going over vast amounts of documentation and crunching numbers.

There will also be interviews of you and/or your employees to ask questions about business operations, accounting practices, and the “who, what, when, where, or why” of a particular business expense, tax deduction, office procedure, or financial document.

Saying the wrong thing or providing additional information that goes beyond what the IRS asks for can make the audit process even worse for you. Giving the wrong information (or giving more than requested) can result in audits that cover additional tax years or make the IRS suspect you or your business of unlawful tax conduct, such as civil tax fraud or criminal tax evasion.

Therefore, it’s important to get professional help if you don’t fully understand the reason for the audit or what could happen if you fail the audit. Even if you understand these two things very well, you might still want to get tax audit assistance to make sure you don’t accidentally divulge too much information or provide the wrong information to the IRS. 

How the IRS Audit Ends 

An IRS audit can end in three possible ways:

• No changes to your tax return.
• The IRS proposes changes to your tax return, and you agree with those changes.
• The IRS proposed changes to your tax return, and you disagree with those changes.

If you disagree with the proposed changes from the IRS, you can request a conference with an IRS manager. Alternatively, you can request your case be sent to mediation, file an appeal, or you can request audit reconsideration.

Consider working with a professional at this point if you’ve gone through the audit on your own. A tax attorney can help you decide the best way to dispute the audit – for example, they may recommend filing Form 12661 to dispute the results.

What Happens If You Don’t Have the Necessary Documentation? 

The good news is that you won’t automatically fail the audit solely because you don’t have receipts or other necessary documents. The bad news is that this will make your audit process more difficult and could make it easier to fail the audit.

The whole reason the IRS audits you is to place the burden on you to confirm what you’ve claimed or reported on your tax return. If you can’t meet this burden, then the IRS has no choice but to conclude you’re not eligible for a deduction, you made a mistake reporting your income, or you improperly claimed some other tax benefit. This can lead to a tax bill that consists not just of unpaid taxes, but also penalties and interest.

If you can’t find a document the IRS has asked for, there are several options to consider before giving up and assuming the worst will happen.

• Ask a third party – A good example of this would be financial documents from a brokerage firm, a payroll company, or a bank where you were a customer or client. Depending on their document retention policy, they might be able to send you extra copies of statements or other documents they already sent you, but you no longer have.

• Provide reasonable estimates – The Cohan Rule allows you to provide an estimate of a business expense, but only if you can show you don’t have copies of the receipts and your estimates are reasonable. In some cases, you’ll also need to provide circumstantial evidence to support the deduction.

To demonstrate the Cohan Rule, let’s think about a hypothetical situation where you want to deduct airplane tickets as a business travel expense, but you don’t have a receipt for the ticket purchase. Circumstantial evidence might include rideshare receipts between the airports and hotels from the trip and calendar entries indicating a business trip with destinations that coincide with those hotel and airport locations.

As for the amount of the deduction, you could estimate the ticket cost by examining historical and industry-standard ticket data for the dates you were out of town.

• Look for alternative records – If you bought a new camera for your photography business and don’t have the receipt from the camera store, you might look at the credit card statement used for the purchase. You could then find the camera store on the statement and use the amount listed as your “receipt.”

In case you’re wondering, not having the documentation to support information on your tax return is not illegal. Yet consistently lacking documentation that most business or individual taxpayers would have access to could raise suspicions with the IRS and make them think the lack of records is deliberate because you’re engaged in tax fraud or tax evasion. 

What Happens During a Tax Audit: FAQs 

Can the IRS audit cover multiple years? 

Yes, however, the IRS won’t typically conduct an audit that covers more than the last three years’ worth of returns. If the IRS finds a significant mistake, they can add additional years to the audit, although they typically won’t include more than the previous six years. 

What should I do if I get an audit letter in the mail? 

Carefully read the notice and make a note of any deadlines. If you understand what the problem is, that’s great. If you don’t understand what the IRS is seeking from you (or why), then it’s a good idea to consult with a tax audit professional. The last thing you should do is ignore this letter. 

Can the IRS show up unannounced to audit me? 

Probably not. The IRS used to make surprise visits using revenue officers, but those weren’t for audits and were instead to follow up with taxpayers concerning unpaid taxes and/or unfiled tax returns. The IRS has largely stopped this practice for safety reasons, as well as to reduce confusion – many taxpayers thought these individuals showing up randomly at their home or office were scam artists, and scam artists also took advantage of these processes to trick people into thinking they were auditors.

An unannounced audit makes little sense and may result in wasted time for the IRS because the audit will likely ask for things that can’t readily or easily be produced. This is why the IRS will schedule the office or field audit ahead of time, giving you time to gather the documents and information the IRS needs to complete the audit. 

Will amending my tax return avoid an audit of the original return? 

No, filing an amended return won’t affect whether or not the IRS selects your original tax return for audit. And just like the original return, the amended return can potentially be audited by the IRS. 

Can I handle an IRS tax audit by myself? 

You certainly can, but it’s usually only a good idea if you fully understand why you were audited and can easily provide the documents to support the information you provided on the tax return in question. However, you should strongly consider talking to a tax audit professional in the following situations:

• The audit could result in a significant tax assessment against you;
• You don’t understand why you’re being audited;
• You don’t know where to obtain the documents the IRS is requesting;
• You aren’t sure if the documents requested by the IRS exist; or
• The IRS wants to conduct a field or office audit.

Importance of Getting Professional Tax Help for an Audit 

As you can see, there are many ways an audit can go, whether in your favor or against you. Depending on the complexity of your tax return, it’s usually a good idea to seek the services of a tax audit professional, such as one from Damiens Law. Their biggest benefit comes not from fixing problems you bring to them, but spotting potential problems you didn’t even know existed.

What might seem like a harmless document request, if not handled properly, could lead to more extensive audits covering additional years and tax issues. If you got an audit letter in the mail that you’re worried about, contact us to schedule a free consultation.

Sources
https://www.irs.gov/businesses/small-businesses-self-employed/irs-audits https://www.irs.gov/newsroom/irs-ends-unannounced-revenue-officer-visits-to-taxpayers-major-change-to-end-confusion-enhance-safety-as-part-of-larger-agency-transformation-efforts
https://www.irs.gov/individuals/understanding-your-irs-notice-or-letter
https://www.gao.gov/products/gao-24-106126
https://www.propublica.org/article/earned-income-tax-credit-irs-audit-working-poor
https://www.irs.gov/pub/irs-pdf/p55b.pdfhttps://www.gao.gov/products/100316