An audit is an official IRS examination of a federal tax return. Audits terrify taxpayers because it can seem as though the IRS has almost unlimited powers. To a certain extent, however, the IRS does have extremely broad authority.
TIP: If you get a notice that you are being audited, consider following the rule that the taxpayer never directly speaks with the auditor. Get your CPA, lawyer or a tax advocate to represent you if it all possible.
What is an audit?
An IRS audit is a review of your tax return to confirm its accuracy. Field and office audits typically include a taxpayer interview as well as an examination of documents.
What kinds of audits can the IRS perform?
There are three different types of audits:
- Correspondence audit. Most taxpayers are generally "audited" by getting a notice from the IRS regarding one or two items on their tax return. For example, the IRS may want to see documentation of your large noncash charitable donations. If you have receipts from the charity and have kept records of the items given, the IRS will probably be satisfied and the matter will be closed. Most taxpayers can competently handle their own correspondence audits.
- Field audit. The field audit is an on-site visit from an IRS auditor and typically occurs with businesses. The auditor examines the business records, bookkeeping methods and other accounting systems that are in place. For example, an auditor might come to a taxpayer's home to check the accuracy of his home office deductions-including measuring the square footage of the office.
- Office audit. If you have been summoned to your local IRS office, the auditors have determined your tax return warrants an office audit. You must appear at the time and date requested in the notification, with the documents specified in the notice. Before you go, it is highly recommended you consult a tax lawyer to help you gather the documents the auditor has requested and only those documents. Bringing documents relating to other matters only has the potential for broadening the subject matter of the audit.
Who gets audited?
Typically, three types of taxpayers are the most frequently audited by the IRS:
- Those who take large and unusual deductions-donating a vehicle to charity, for example.
- Pofessionals who bill for their services, set their rates, handle their own booking, etc., such as accountants, lawyers and doctors
- Any cash business, or taxpayers receiving a substantial portion of their income from cash, such as bars, waiters, cosmetologists, etc.
What are the reasons for audits?
The IRS "scores" returns using a computer program and those tax returns that have a certain score are likely to be audited. The score is based on the probability that the tax return omitted income. Your tax return can also be audited if documents are missing, there is a questionable item (such as a deduction) or the IRS has received information that you may be committing tax fraud.
How can I avoid an audit?
Taxpayers who keep written records of their expenses and deductions can often deflect an audit. In other words, if the IRS is suspicious of your tax return's accuracy and begins by questioning your charitable donations, it may back off if you can provide impeccable documentation of the donations. Additionally, sloppy tax return preparation raises a red flag. Before filing a return, double-check and triple-check your numbers and math. Finally, if you are in one of the categories of taxpayers that the IRS frequently audits, set up a method of recording expenses and income.
Can I be audited if my CPA prepared my return, handled all my records and receipts and decided what deductions should be taken?
Yes. The taxpayer is ultimately responsible (and liable) for her tax return although someone else prepared it. If there are errors on the return, you are assessed back taxes, penalties and interest.
TIP: Always keep the original records or a copy of any documents that back up your tax return's accuracy. You are responsible for maintaining records and if your preparer loses or misplaces documents, it will be impossible to defend an audit.
What is the best way to defend an audit?
The best way to defend an audit is to begin immediately organizing your records and finding all receipts and other paperwork that show deductions, expenses, mileage and charitable donations. If you speak with an IRS auditor, be calm, courteous and patient. A good attitude will greatly benefit you during the audit process.
A taxpayer should always have representation at any audit beyond the correspondence audit level since the taxpayer is typically interviewed. Tax professionals who aide taxpayers in defending audits may charge a fee of several thousand dollars for such representation. Taxpayers have the right to record the audit interview by giving 10 days' notice to the IRS of their intent to record.
TIP: Individuals and small business owners can take out "audit protection insurance (API)." The insurance provides a certain level of coverage depending on amount of premium paid. Persons with a history of audits and those who do not have their returns professionally prepared may not be eligible for audit insurance.
Am I entitled to be represented during the audit?
Yes. You can be represented by an attorney, a certified public accountant, an enrolled agent (a person enrolled to practice before the IRS), an enrolled actuary or the person who prepared the return and signed it as the preparer.
TIP: Former IRS employees often go into the business of representing taxpayers at audits.
I have been summoned to the IRS offices. Do I have the right to have the audit take place at my attorney's office?
No. The IRS decides when, where and how the audit will take place.
TIP: Taxpayers must be treated fairly and courteously. Make sure you are aware of your rights as a taxpayer when you are before the IRS. Some taxpayer rights include:
- the right to representation at any IRS hearing;
- the right to record interviews by IRS employees, auditors and agents;
- the right to end the interview;
- the right appeal the auditor's decisions; and
- the right to obtain help from the Taxpayer Advocate's Office.
Your rights are explained at www.irs.gov/pub/irs-pdf/p1.pdf.
Can I appeal an audit?
A taxpayer has the right to formally agree or disagree with the auditor's conclusions. By agreeing, the taxpayer concludes the audit; however he must pay any amounts due plus penalties that have been assessed against him.
Disagreeing with the audit puts the taxpayer into an appeals process. A supervisor in the IRS office may review the audit or the taxpayer can go directly to the IRS Appeals Office. From there, the appeal goes to U.S. Tax Court. Appeals from Tax Court are made to federal District Courts.
TIP: If you cannot resolve the issue with a supervisor, you have the right contact the IRS Taxpayer Advocate Service. The Taxpayer Advocate Service is an independent organization within the IRS whose goal is to help taxpayers resolve problems with the IRS.
My audit is over and I won; however, my business has suffered irreparable damage as a result of the IRS's actions. Do I have any recourse?
Yes. Federal law allows you to sue the IRS for damages as a result of the agency's negligence. Your recovery is limited to $100,000 plus attorney's fee and costs.
Can I be subject to criminal charges because of my tax filing?
Taxpayers who are suspected of "cheating" on their taxes or of being involved in fraudulent activities may find themselves under criminal investigation by IRS agents. Tax fraud means that the taxpayer is willfully hiding or attempting to hide income from the IRS.
Example: Typical crimes include tax evasion, failure to file or filing a false tax return.
Some of these individuals are nonfilers who are challenging the constitutionality of taxes, claims for fraudulent refunds, abusive trust schemes and unscrupulous tax return preparers.