Tax audits are further examinations of someone’s tax by the IRS when they consider there is a need to closely verify whether the income and the deductions are accurate. Here’s everything you need to know about them.
A tax audit is when the IRS (Internal Revenue Service) decides to examine someone’s tax returns a little more closely to verify that their income and deductions are accurate. A tax return is often chosen for an audit when something entered on the return seems out of the ordinary. There are three distinct types of IRS audit – the office audit, the field audit, and the mail audit. Field audits are the broadest type of examination that the IRS conducts.
In these instances, an IRS agent will conduct the audit at your place of business or at your home if you have a home office. Generally speaking, field audits are conducted when more deductions are being questioned, and are generally very thorough. Furthermore, an office audit is an in-person audit conducted at the local IRS office and these audits are more in-depth than mail audits since they usually include a question.
This questioning will shed light on specific information to an office audit such as the records and the books of your business. It’s important to note that you are entitled to an accountant or a lawyer to represent you at these meetings. Mail audits are the simplest type of IRS examination and don’t require a meeting with an auditor in person. In mail audits, the IRS will request additional documentation to substantiate some items you report on your tax return.
There are a few key steps that need to be taken if you were to address an IRS audit properly. As the creators of Tax Shark note, firstly, you need to understand the scope of the tax audit and prepare your responses to the IRS questions. Secondly, you should respond with the prepared answers and provide an auditor with documents and information on time, and advocate for yourself. Lastly, if you disagree with the results, you are entitled to appeal to the appropriate venue.
As far as the first step is concerned, understanding the source of the audit means that you’re acquainted with the aforementioned three types of audit (mail, office, and field audits). Then you can prepare your responses – for a mail audit prepare a complete response to all the items in the document you received. field and office audits, prepare for the meetings with your lawyer or an accountant.
The third step is to respond to all of their requests where they could either agree or disagree with you. Ultimately, the IRS auditor will close the tax audit, either proposing no changes or adjustments to your return. If you disagree with the results, you can request an appeal within 30 days with the IRS Office of Appeals. Once this time expires you will be sent a Statutory Notice of Deficiency which will close the tax audit and allow you to petition to the U.S. Tax Court.
There is a wide variety of potential triggers in tax returns that can raise questions and attract unwanted attention from the IRS. The way these are discovered is through a computer scoring system that the IRS uses called the DIF system (Discriminant Information Function), which is used to analyze tax deductions. In addition to this, the DIF system compares taxpayer data and is often a good basis to initiate an audit.
Some of the common ways issues can crop up is when income is not fully reported or if the business operating losses are deemed atypical. Additional triggers include inconsistencies or errors in the return, as well as omissions and some lavish business expenses (such as for meals and entertainment). Moreover, a sharp drop in reported income in-between years is also a trigger.
Some of the bigger and more obvious triggers are exceptionally large charitable deductions, however, they are allowed when there is the proper documentation and receipts to back them up. In addition to these large charitable deductions, making a lot of money can also be a big trigger warning since the majority of tax returns that have been audited belong to taxpayers with an income that is in the range of millions. Furthermore, having a foreign bank account can oftentimes be a trigger or a red flag that may bring on an audit.
If you ever face a tax audit, have these things in mind. Moreover, be sure to have proper tax audit representation just to ensure nothing gets missed.