Do you know? In 2024, the IRS audited 505,514 tax returns! And it resulted in an additional $29.00 billion in tax revenue. The amount is massive, which is why the IRS continues to perform audits every year! Stressed about what an audit is? What happens if you get audits, and do you need a tax representative in your case? Hang on! We will eliminate all your concerns one by one in this blog.
What is an IRS Audit?
The foremost important question is, what exactly is an IRS audit? Well, an IRS audit is an official review of your financial records and information to ensure your tax returns are accurate and in accordance with tax compliance standards.
Purpose:
The IRS conducts these audits to ensure the right amount of tax is paid to the federal government. It’s simply a way to reduce tax evasion and other similar crimes. Furthermore, history shows that the IRS audit always results in more tax recovery every year.
Types of Audits:
Audits can vary from a simple mail inquiry to an in-person examination of your records. Here are the details of each audit:
- Correspondence Audit (Mail Audit): For simple issues that can be resolved without an in-person meeting, they are done via mail audit. The IRS will send you a letter requesting additional documents or clarification of specific tax returns.
- Office Audit: For complex information, the IRS will notify you to schedule an in-person meeting with a local IRS auditor. It typically occurs due to itemized deductions or claims of business expenses. It is recommended to go with a tax professional for this type of audit.
- Field Audit: This is the most serious audit, requiring comprehensive documentation and records. An IRS agent will visit your business place or home to thoroughly examine your financial records.
In addition to these three, there’s a less common type of audit, like a Taxpayer Compliance Measurement Program (TCMP) Audit. These are very detailed, line-by-line audits of randomly selected returns. The purpose is not to find errors in a specific taxpayer’s return, but to collect data for the IRS to use in improving its computer-based audit selection systems. These are rare but extremely thorough.
Why Did I Get Audited? Understanding the Triggers
Jumping from basics! Time to know why you can get audited? Actually, there is no single reason that can determine whether you can get audited or not. In fact, the IRS sometimes conducts random audits. Clean records and proper tax filing can result in a clean chit, though.
Factors increasing your chance of audit include:
Statistical Analysis:
The IRS uses a computer system to flag returns with a high potential for error, often comparing your deductions and income to those of others in your income bracket.
Common Red Flags for Audit:
- Extraordinary high deductions, such as claiming a home office deduction that seems too large for your income.
- Failing to report all income. For instance, from freelance work or investments.
- Large charitable donations, especially in relation to your income.
- Claiming business losses year after year on a hobby.
- Significant business expenses or car and travel deductions.
- Errors in math or incomplete information on your tax return.
Third-Party Information:
Discrepancies between your return and information reported by others, such as employers (W-2) and banks (1099), are a major trigger.
The Audit Process: What to Expect and How to Respond
Once you are selected for an audit (unfortunately), the IRS will contact you via mail.
Quick Note: The IRS never contacts you by phone. If you are contacted by phone, it’s more likely a scam call. Never share your personal details via a call. Use the official IRS mail address to provide any information.
Steps involved in the audit process:
First Contact:
When the IRS contacts you via mail, they provide all information required by the department for your specific audit. This notice will also explain which tax year is being reviewed, the reason for the audit, and what documents you need to provide.
The Statute of Limitations:
The IRS generally has three years from the date you filed your return to conduct an audit. However, this can be extended in cases of significant underreporting or fraud. Don’t worry about record-keeping if the audit is for an extended period. The old record can be lost, and the IRS totally understands it. You can use the Cohan rule (estimate of income and expense) for your benefit in these scenarios.
Preparing for the Audit:
Never ever panic if you get an audit request! You can always prepare for it. Moreover, it doesn’t always mean an extra tax bill. Follow these steps to prepare yourself for the audit!
- Gather Your Records: Collect all requested documents, including receipts, bank statements, and any other evidence to support your tax return claims. For lost records, you can use pictures, a diary, and meeting logs for your benefit.
- Can bank statements be used as receipts? While receipts are best, bank statements can serve as supporting evidence, especially when combined with other documentation.
- Hire a Professional: You have the right to be represented by a business tax professional, such as a CPA or an enrolled agent. They will communicate with the IRS on your behalf.
Potential Outcomes: What Happens After an Audit?
Statistically, most of the audits result in added tax bills. However, if you properly represent your documents and records, there can be no tax due. Surprisingly, you can expect a refund too! Following are outcomes of an IRS audit:
- No Change: The IRS finds no issues with your return, and the audit is closed. You will get a clean chit!
- Tax Due: The IRS determines you owe additional taxes. You will be given a chance to agree to the changes or appeal the decision. If you agree to pay, no further steps are needed! Also, you can appeal, which leads to additional record requirements and a solid case. But you can save from potential tax bills.
- Refund Due: In some cases, the audit can reveal that you are entitled to a refund. Yahoo! A big win!
- Penalties and Penalties: If the IRS finds significant underreporting or fraud, you may face penalties in addition to the taxes owed. For extreme cases, if you are found guilty of tax theft, prison time can be expected!
- Winning an Appeal: If you disagree with the audit’s findings, you can file an appeal. If your appeal is successful, the initial audit decision can be reversed. Another win with a significant amount of savings!
Final Verdict
An IRS audit is a routine part of tax administration. The audit can happen to anyone. It doesn’t directly mean tax evasion, theft, or underreporting. By understanding the process and being prepared, you can significantly reduce the stress and uncertainty.
The best strategy is to maintain organized records and be honest and thorough when filing your taxes. Also, hire a qualified tax accountant to represent your case. Remember, the IRS’s primary goal is compliance, not to arrest you, which is a rare and extreme measure reserved for cases of severe tax fraud.
Your Question Answered Here!
In some cases, you might get a tax refund. If an IRS audit found you overpaid your taxes. You are entitled to get a tax refund. On the other hand, your refunds can be withheld if the IRS sends you an audit notice.
No, the IRS has no authority to look at your bank account without permission. However, banks are required to share some transaction details with the IRS, such as Form 1099-INT and similar forms. That means the IRS already has some of your account details at hand!
It is important to keep receipts of all capital improvements. Although if you miss some, you can use other documents. Such as:
- Bank or credit card statements showing the payments.
- Cancelled checks that identify the payee.
- Emails or contracts with the contractor or supplier.
- Invoices or bills for the work done.
Yes. The IRS itself is subject to review by the Government Accountability Office (GAO), the Treasury Inspector General for Tax Administration (TIGTA), and congressional committees. This ensures that the IRS itself follows tax laws and procedures.
Cohan Rule is a legal principle that allows taxpayers to deduct certain business expenses, even without receipts.
If you don’t have receipts, you’re at a higher risk of having your deductions disallowed. The IRS will look for alternative documentation to support your claims. If they are not convinced, they will disallow the deductions. And in some cases, you will owe additional taxes, along with potential penalties and interest.
There are very few chances of getting audited. Especially if you are a salaried employee with less than $400,000 in income. However, if you are self-employed or have saturated returns with multiple deductions, the chances can be high. Remember, the IRS usually performs audits on less than 1%.
Failing an audit means the IRS has found that you owe additional taxes based on their review. This will likely result in a revised tax bill, which includes:
- The additional taxes owed.
- Interest on the underpaid tax, which accrues from the original due date of the return.
- Penalties, which can vary depending on the reason for the underpayment.
You can either agree to pay the new amount or appeal the decision. In rare cases of severe fraud, a civil audit can be referred for criminal investigation, which could lead to prosecution.
The IRS doesn’t audit a bank account in isolation. In fact, the IRS cannot access your bank accounts without permission. Rather, it audits your tax return, and your bank account records may be requested as part of that audit. This is most common when the IRS suspects unreported income.
