As careful and meticulous as you might be in preparing your income tax return, you may find yourself shocked and dismayed to discover an audit notice from the IRS in your mailbox. However, the likelihood of an IRS audit is small and has been dropping in recent years. Currently, the IRS is auditing less than 1% of all individual income tax return filers. While it is a low percentage, it still is a possibility. So while an audit may at first seem like the end of the world, knowing what to expect and how to prepare can help ease some of the anxiety that comes with being audited.
Many audits may be resolved completely by mail, without any face-to-face interaction with an IRS agent. Referred to as correspondence audits, these comprised the majority of all audits of individual income tax returns performed by the IRS. The other 23% of audits were field audits, which involve meeting an IRS agent at your home, place of business, or other location deemed appropriate. The following tips will help in getting ready for either type of audit.
The IRS doesn’t like it if you ignore their notices. An audit notice sent by the IRS typically allows the taxpayer 30 days to respond. Failure to respond in the allotted time may result in an automatic adjustment (increase) to your tax liability, as well as forfeiture of your right to appeal any decisions made by the IRS.
Being organized will help the audit process to move along more smoothly and quickly. This allows the IRS agent to more easily perform their job, and portrays you in a more positive light. The process of getting everything in order will also help ensure that you are not missing any necessary documents. The IRS takes a dim view of undocumented deductions.
Obtain copies of lost documentation
If you find that any necessary documents for the items in question are missing, take care to obtain replacements prior to the audit. Failure to provide proper documentation will probably result in the loss of a deduction you were rightfully entitled to, and increase your tax bill for the year.
Familiarize yourself with the issue
Review your tax return for the year being audited thoroughly, focusing on the items being questioned. If possible, read the applicable tax code and understand how it applies to your situation. A certified public accountant or tax attorney may be your best bet, particularly when dealing with complex issues.
Issues that are likely to be brought up by the IRS in an audit include:
- Auto expense, particularly if the business use percentage is high.
- Travel and entertainment deductions
- Charitable contributions, particularly non-cash (“thrift shop”) contributions exceeding $500.
- Any mismatch between amounts reported to the IRS on W-2s, 1099s, etc., and amounts reported on your income tax returns.
- Any discrepancy between bank deposits and gross receipts. IRS will request bank records and compare the deposits with amounts you have reported.
Provide only copies of documents
It is important to know that the IRS is not legally responsible for the loss or misplacement of any documents in its possession. It is difficult to provide evidence for a deduction if the original or only copy of a necessary document is lost or misplaced by the IRS. Make copies of your documents prior to the audit, and provide the IRS with only these copies.
Do not offer any more information than necessary
Don’t volunteer information. Only provide records for the tax year(s) requested and only pertaining to the items in question. Avoid providing any information, even verbally, about other personal or business matters. In some cases, the agent may decide to expand the scope of the audit to include the areas that you inadvertently volunteered information about. If you are asked a question not related to the audit at hand, politely decline to answer. The IRS is required to make such requests in writing.
Prepare for the worst
The IRS does not randomly select tax returns for audit. Rather, a number of criteria are used to pick out those that are most likely to contain errors or misstatements. Taxpayers with certain types of businesses that deal in a high volume of cash transactions, itemized deductions that appear high in relation to income, excessive travel or meals and entertainment expenses, and those with higher incomes are more likely to be audited. For this reason, the vast majority of audits result in additional liability for the taxpayer. Preparing for this very real possibility will make the ultimate result easier to accept, especially if it is not in your favor.
Be willing to accept small adjustments from the IRS
The IRS agent may propose minor adjustments, for example, personal use of cell phones, where 100% business use has been claimed. When the IRS agent suggests a relatively small adjustment to your tax liability for the year, it may be less costly to pay that amount upfront, rather than spending time and money (remember that the IRS is accruing interest on your tax liability) trying to fight it.
Know your rights as a taxpayer
Many provisions are in place to protect taxpayers in the event of an audit. When the examination is completed, the IRS will send you what is referred to as a 30 day letter. That means you have 30 days to either appeal the decision to the Appellate Division, or pay the additional tax, penalties and interest. You may also request an extension to allow more time to prepare for an audit, as well as ways to appeal decisions made about your tax liability. These provisions can be found in IRS Publication 556: Examination of Returns, Appeal Rights, and Claims for Refund, on the IRS website, www.irs.gov.
Consult a tax professional
Do not hesitate to consult with a certified public accountant or tax attorney, or enrolled agent if the issue is large and/or complicated.
The thought of an IRS audit strikes fear into the heart of every American taxpayer. If you happen to be among that unlucky 1%, rest a little easier, knowing that you are now armed with the tools and know-how to survive that dreaded audit relatively unscathed.