The IRS has 3 years from the date a return is filed to request an audit. However if a taxpayer is suspected of having underreported their income by 25%+, the IRS can go back as far as 6 years. And where actual taxpayer fraud is suspected, there is no limit as to how far back they may go. Of course being audited by the IRS will rank very high on nearly every Americans list of most feared events but it doesn’t need to be the dreaded experience one imagines. Below is an overview of conditions which might trigger an audit along with advice on what to do and how to proceed in the event you are audited.
Tagged by IRS Computer Analysis – just like the credit scoring system we all know as FICO, the IRS has their own unique model for ranking taxpayer risk and analyzing which returns require further inquiry. A substantial 80% of all audits are initiated this way.
Random IRS Selection – lucky you, it’s a case of wrong place, wrong time. A small percentage of returns are selected this way.
Expenses vs. Income are Disproportionate – when the expenses you have claimed on your return appear too high relative to your income.
Designated Fields or Professions – there are particular professions which are deemed to be at a higher risk of malfeasance by the IRS and are therefore more likely to be subject to an audit.
A Habitual Problem Child – you are a taxpayer who has had previous problems with the IRS and may have been audited before and perhaps even lost a prior tax dispute with the IRS.
Types of Audits:
The majority of audits are correspondence audits which will take place through the mail. Audits which require you to appear before an IRS agent typically occur at an IRS field office and you’ll receive a notice of when and where to appear and which documents you will need to bring along with you. The audit will likely have a particular focus or theme and fortunately it is unlikely your complete return will be picked apart page by page. The focus of the audit should cover the primary areas of emphasis and should last a few hours. The scariest audit is the field audit where an IRS agent will actually come to you. Typically this type of audit will occur at your place of business and is more common amongst small business owners. Also with this type of audit, you will likely want to have a tax professional representing you as the likelihood that you could owe additional taxes is very high.
Preparing for an Audit:
Deciding whether to go it alone or get some hired help. If you are in the practice of preparing your own tax return and have a clear understanding of the areas of your return which are under question by the IRS, then you may want to handle things yourself. Also if the amount disputed is relatively small in contrast with the fees involved in hiring professional tax representation, then it makes sense to simply go it alone. Conversely if the amount in question is substantial or if you do not prepare your own return, then you will want your tax preparer’s assistance in representing you.
Let the IRS inquiry guide your behavior. Do not offer more information than what is being asked for, focus only on the sections of the return which are being questioned. And do not bring more information or documentation with you than that which has been requested. If in fact the IRS auditor inquires about items of the return not originally outlined in your audit notice, respectfully let them know you were not prepared to review or discuss those items and should schedule an additional meeting.
Check your attitude at the door. No one likes the IRS but having a hostile or combative attitude towards the audit or the auditor will only work against you. It is obvious to say and difficult to put into practice but you will end up being your own worst enemy if you become argumentative with the auditor. Maintain your composure and keep your cool. Think of the worst thing that could happen during the course of the audit and measure your reaction ahead of time. When you find yourself disagreeing with the auditor state your position as professionally and precisely as possible only once and then let it go. If you are being represented, your tax professional should know how to correctly respond to any issues in dispute. Keep in mind you do have additional recourse by taking your case to the next level above your auditor and if need be on to tax court if you feel the auditor’s and IRS’s decision is incorrect.
Remember that your auditor is only human and a taxpayer too. Be respectful, organized, and informed at the appointment. You don’t need to be friendly but there is no reason to be rude or contemptuous either, the auditor is only doing their job and it is not a pleasant one. Being an auditor is a highly stressful position and not a very popular one either. The experience level of an auditor could be such that they are fresh out of school and know only slightly more about the technicalities of the tax code than you do. If in fact you have hired representation, your tax professional will likely be the one in the room that is most knowledgeable in areas involving the tax code. Therefore there’s no reason to allow the whole process to overwhelm you.
Lastly if, and more than likely it is determined that you do owe additional taxes, better to get it over with sooner rather than later as interest and penalties will rack up quickly compounding your financial pain. If you cannot pay all that you owe at once, setting up a payment plan is a prudent option.
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