IRS Income Tax Audits

An income tax audit is an examination of a tax return. Depending on the nature and scope of the audit, an IRS examiner may look at just a few items on your return or they may look at your return in its entirety. If they determine that certain items do not add up to the amounts reported on the return or that a position taken on the return is questionable, they will require you to justify that item. This outcome of this process can lead to one of three results: owing more tax, owing no additional tax, or in rare cases, receiving a refund.

Types of Audits

Correspondence Audit

The IRS uses correspondence audits to take care of the most common tax return problems, such as missing forms and schedules, illegible entries, and mathematical errors. These take place via mail and constitute the majority of the audits that the IRS conducts.

Office Audit

In an office audit, you go to an examiner’s office and present documentation and information, such as receipts, account statements, or pay stubs, in order to substantiate certain items on you return.

Field Audit

Field audits are the least common type of audit conducted by the IRS. During these audits, an examiner will arrange a time to visit your home or business to verify the information on your return.

Why Me?

Although recent IRS controversies may lead you to think that the IRS targets particular individuals or groups, this kind of behavior is an aberration. In reality, a piece of software called the Discriminant Inventory Function System (DIFS) analyzes tax returns. This software looks for variances between returns filed by similarly situated taxpayers and assigns each return a score based on its deviation from the average.

Example         If the DIFS determines that the average unreimbursed business expense claimed by taxpayers who work in construction is $1,000 and you claim $10,000 on your return, your return will be assigned a higher score, which may trigger an audit.

This scoring system has nothing to do with the correctness of your return. It merely operates under the assumption that returns with large statistical variance are more likely to contain errors than returns that are close to the average.

What should I do if I am audited?

Do not ignore your audit notice! This is a common mistake made by individuals who either do not understand the audit process or do not want to deal with the IRS. Once the IRS has chosen you for an audit, they will not go away. The worst thing that you can do is not respond. If you do not respond by the date on your notice, the IRS will likely assess more tax than you otherwise would have owed.

Example         A taxpayer is audited for not reporting a Schedule C business on his return. The business made $100,000 in sales and had $75,000 in expenses for the year. Rather than respond to the audit, the taxpayer throws away the audit notice. In cases like this, the IRS only has access to the amount of income that should have been reported. There is no way for them to verify whether any expenses were paid. Since the taxpayer did not respond to the audit, the auditor will only base the assessment off of the business’ income, which will result in tax being assessed on $100,000 rather than $25,000. 

In most small audits, as long you have good records and are able to explain why the amounts claimed on your return are correct, the IRS will close your audit with no changes. Larger audits, on the other hand, can be more cumbersome to handle. As a general matter, the larger the scope of an audit, the more aggressive the IRS will be in requiring substantiation of the items under audit. In these cases, many taxpayers turn to tax professionals for help.

The benefits of hiring a tax professional where an audit change can result in a large tax assessment can be immense. These individuals are keenly aware of not only the current state of the tax code, but also various strategies that can be implemented during an audit to obtain favorable results. In addition, tax professionals act as a barrier between you and the IRS. By having a tax professional represent you in your audit, you never have to see or hear from an IRS agent and you can be sure that the IRS will not take advantage of your unfamiliarity with both the audit process and the tax code.

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Please keep in mind the information and advice presented in this blog is not intended to be used as formal legal advice. Contact a tax professional for personalized tax advice pertaining to your specific situation. While we try and answer all parts of the question when we write our blogs, sometimes there may be some left unanswered. If you have any questions about your problems with the IRS, SBOE, FTB, or BOE, or tax law in general, call RJS Law at (619) 595-1655.