Once you file your income taxes, the IRS will review all the forms you submit, and either issue your return or refund, usually with very little turnaround time. However, occasionally the IRS will ask you to provide some supporting documentation before your return is accepted.
The Basics of an Audit
An “Audit” is what happens when the IRS picks your return out from the pile for extra scrutiny. The auditing process is designed to catch errors in the tax returns, verify the correct amount of tax or return is being paid, and preventing fraudulent tax claims.
These can be triggered by a random selection or if your return has any causes of suspicion. Audits are normally triggered within 3 years of filing, but in some cases can be up to 6 years after filing your initial return. If you file taxes with a professional accountant, that accountant will usually accompany you through the entire auditing process and do almost all of the leg work. If you file on your own, you will need to go through the auditing process on your own as well.
The reason for this is mostly political – congress has repeatedly cut the IRS budget over the last few years, resulting in tens of thousands of fewer auditors, with far less training each, so each individual audit takes longer each year, with a growing backlog. What this means for you is that you need to keep all financial records used to prepare your tax return for about 7 years to make sure you are prepared in case of an audit. This also means fewer audits are conducted due to random selection, and more due to your return triggering an audit due to suspicious activity.
What is suspicious about my return?
IRS auditing agents do not read every tax return. Most tax returns are processed automatically, with the data read, processed, and stored by a computer. Since all this data is in one place, the IRS has a research division that carefully combs through all the data to find statistical patterns. They use these statistics to build models of what most returns “should” look like given what the person is claiming. For example, married couples with children’s returns look more similar than single people filing alone.
When returns come in that do not fall in line with what would be “expected”, that return gets flagged for an audit, where an IRS expert gives it a closer look.
What do auditors need?
Auditors need to see your financial records to verify that the claims you make on your tax return are accurate and justified. You should not need to generate any new records for an audit – generally you will only need the same documents you should have had on hand while filing.
If you do need to submit any documents to the IRS, each document should include a note of what it is and how it applies to their request and your return. Click here for a list of the records that auditors might request.
Steps of an Audit
There are two basic steps of an audit. First, when your return is first flagged for an audit, it first is taken by an experienced auditor and analyzed in detail. This auditor can either accept your return as is, or be forwarded to an examining group.
If this first auditor accepts your return with no changes, it continues to be processed normally, and you may not even be aware it was ever flagged at all.
If it was forwarded on to an examination group, you will be notified by mail of what exactly the auditors are looking in to. You can be audited either in person or by mail, usually depending on the complexity of your return and how many flags were raised by the first auditor.
You will always and only be notified by mail – the IRS will never call you to inform you of an audit or demand payment (this is a very common scam).
Audits by Mail
Audits by mail are very easy affairs – the documents you receive from the IRS will specify why you are being audited and what they are looking for, and will ask you to mail them specific supporting documentation (usually receipts, logs, or records detailing your expenses). You simply need to mail them back copies of those documents (never the original, since that could be lost in the mail), and they will review what you provide.
Audits in Person
In-person audits are a more formal affair. They can either ask you to come in person to a local IRS office, or send an agent to meet with you at home, place of work, or with your accountant. You will have a choice for the date and location, which must be arranged with your auditor.
In person audits are usually done for more complex audits, were several flags were raised with your return, allowing for the auditor to ask you specific questions about specific items.
If you are called for an in-person audit, the IRS will still specify the specific reasons why you are being audited and will request specific documentation, but it is always a good idea to bring as much documentation as possible. You should still be using only copies – the auditors may need to keep some of your records as they make their decision, so they should not be given originals.
After you mail your documentation or meet with the auditors, they will confer and discuss your return and the information you have provided. You will always be notified when an audit has concluded and they have reached their decision.
The auditing team will either accept your return with no changes (meaning they were satisfied with the documentation you provided), or request changes. You can either accept or reject their proposed changes.
If you accept the changes, you will sign a document confirming you understand and agree to the changes. This has the same effect as filing a revised tax return. If this means you owe additional taxes, you will need to pay them either at this time or in installments.
If you reject the changes, you can request a conference with a higher-ranked IRS agent, who will review the auditing process and your objections. If you disagree with this agent as well, you can take your case to mediation (where a third party discusses the issues with both you and the auditing committee), or take your case to Tax Court, where you will need a lawyer to argue your cause in front of a judge.
Very few disputes end in Tax Court, as both most taxpayers and the IRS prefer to resolve the issue through mediation than the expensive legal process. Click Here for more information from the IRS website.