Triggers, Process, and How to Protect Yourself
An IRS tax audit, or “examination,” as the IRS calls it, is a detailed review of your financial records to ensure that the information on your tax return is accurate and in compliance with tax laws. While only a small percentage of tax returns are audited, audits help the IRS address discrepancies, ensure fair tax collection, and reduce tax fraud.
For taxpayers, knowing the triggers and requirements for an audit is invaluable for proactive preparation and avoiding common mistakes.
Common Triggers for an IRS Audit
A variety of red flags can increase your likelihood of being audited. Here are some of the most common triggers:
- High Income Levels: Individuals with higher incomes, especially those earning above $200,000, tend to face more scrutiny, as higher earnings often mean more complex returns.
- Unreported Income: The IRS receives copies of all tax forms, such as W-2s and 1099s, so any missing or unreported income can easily raise a red flag.
- Large or Unusual Deductions: Deductions that appear unusually high relative to your income, such as substantial charitable donations or excessive business expenses, will likely invite further scrutiny.
- Business and Self-Employment Income: Small business owners and self-employed individuals, especially those claiming business losses for multiple years, often face audits due to the potential for over-claimed expenses.
- Foreign Accounts: Foreign assets exceeding $50,000 must be reported on Form 8938. Compliance is closely monitored, with discrepancies raising the risk of an audit.
What to Do if You’re Missing Receipts
One common worry in an audit is missing receipts for claimed deductions. Fortunately, there are ways to substantiate your expenses even if original receipts are unavailable. The Cohan Rule, for instance, allows taxpayers to estimate certain costs without receipts, provided that the expenses are reasonable and credible.
In cases where receipts are missing, alternative documentation can often serve as proof. Bank and credit card statements, canceled checks, and vendor invoices can be used to substantiate expenses. Additionally, you can try to reconstruct records by contacting vendors for copies of past invoices, checking appointment books, or even reviewing phone records for clues about business-related transactions. Suppose capital improvements or major renovations are under scrutiny. In that case, it’s especially important to find and provide as much documentation as possible, as the IRS may require specific records for these claims.
Types of IRS Audits and What to Expect
The IRS conducts audits of varying depths and complexity, depending on the issues involved. There are three primary types of audits: correspondence, office, and field audits.
- Correspondence Audits are the simplest and are typically conducted by mail. In these audits, the IRS will send a letter requesting additional documentation or clarification on specific items in your return. Often, this can be resolved by mailing back the requested information without needing in-person meetings.
- Office Audits require an in-person appointment at an IRS office. Here, an IRS agent will review specific items on your return. You can have representation at this meeting, such as a certified public accountant (CPA) or tax attorney, who can provide added guidance and support.
- Field Audits are the most comprehensive, as they involve an IRS agent visiting your home or place of business to conduct an in-depth review of your financial records. Field audits are generally reserved for more complex cases and may cover multiple tax years. Given the thoroughness of field audits, consulting with a tax professional like Todd Unger is strongly advised to ensure the process goes as smoothly as possible.
Statute of Limitations for IRS Audits
The IRS has a general timeframe for conducting audits or statute of limitations. Typically, the IRS has three years from the filing date or due date to initiate an audit. However, certain conditions can extend this period.
For most taxpayers, the IRS will look only at returns filed within the last three years, but if the return contains significant errors, the IRS may go back as far as six years. A “significant error” usually means underreporting your income by more than 25% or failing to report foreign assets worth over $5,000. In cases of suspected tax fraud or deliberate tax evasion, the IRS can initiate an audit at any time, even decades later, as there is no statute of limitations for fraud.
In some cases, you may be asked by the IRS to extend the limitations period, often to allow more time for completing an ongoing audit or resolving an appeal. These consensual extensions can be helpful if there’s an unresolved issue. Still, it’s important to consult a tax professional before agreeing, as the extension may not always be in your best interest.
Consequences of Failing an Audit
If an audit concludes that there were discrepancies in your return, the IRS may assess additional taxes, penalties, and interest. The most common penalties include the accuracy penalty, which applies if errors on your return led to an understatement of taxes owed, typically resulting in a penalty of 20-40% of the tax increase.
In serious cases, such as tax fraud, the consequences can be severe, ranging from property forfeiture to criminal charges. A conviction for tax fraud can include fines up to $100,000 and potential jail time. However, most audits are resolved without criminal charges, and penalties are often limited to the taxes owed plus interest and fees.
If you did not file your return on time, a late filing penalty may also be assessed. This penalty can be as high as 5% of the unpaid balance for each month the return is late, up to a maximum of 25%.
What to Do if You Owe Money After an Audit
If an audit finds that you owe additional taxes, the IRS offers several ways to manage your payment. You can choose from direct payment options or set up installment plans if you need more time to pay the balance. If you disagree with the audit findings, you can request a conference or file an appeal to ensure a fair outcome.
Here’s an overview of the payment and resolution options:
- Direct Payment Options: Use IRS Direct Pay to transfer funds directly from a bank account or pay by debit or credit card.
- Installment Plans: The IRS offers installment plans for those unable to pay the full amount upfront, which allow for manageable, periodic payments.
- Appeal Options: If you disagree with the audit findings, you can request a conference with an IRS manager or file an appeal if the statute of limitations permits. A tax professional like Todd Unger can help protect your rights and improve your chances of a favorable outcome.
Need Legal Help?
Although an IRS audit may seem intimidating, a thorough understanding of the process, common audit triggers, and the required documentation can help you get through it confidently. You can greatly reduce the risk of audit-related issues by maintaining detailed records, reporting all income accurately, and working with a knowledgeable tax professional.
If you face an audit, consulting with a tax attorney like Todd S. Unger, Esq. can provide the guidance needed to protect your interests and resolve the audit efficiently. Schedule a meeting now!
