Tax Audit Defense

The IRS conducts thousands of reviews of organizations’ and individuals’ tax returns every year in an effort to ensure financial information is accurate according to tax laws. This review is called an audit, in which the IRS examines documentation, reports, accounts and financial information to confirm the tax report is correct.

The IRS is required to contact you via mail to inform you of a tax audit. The Notice of Audit and Examination Scheduled explains that your return has been chosen for a tax audit. It will also explain the specific items on your return that need to be reviewed, as well as the records they need in order to review your account. For instance, the auditor may send you an IDR request on Form 4564.

In order to avoid scams, make sure the IRS audit letter contains the following:

• Your Full Name
• Taxpayer/SS ID Number
• Form Number
• IRS eEmployee ID Number
• IRS Contact Information

This letter should clearly identify the primary reason for the audit and what documents you will be expected to provide.

There are three types of audits:

• Correspondence Audit: The entire audit is conducted through mail and phone conversations.
• Office Audit: The audit takes place at a local IRS office.
• Field Audit: The IRS examiner visits your home or place of business.

The type of audit will determine the depth of the audit, as well as how long it will take.

With all the horror stories circulating, it’s certainly scary to think about getting audited by the IRS. However, while the IRS audits hundreds of thousands of taxpayers every year, the number of audits only adds up to less than 1% of US taxpayers. It’s also important to keep in mind that an audit doesn’t necessarily mean you’ve done anything wrong. In fact, many tax returns are randomly chosen for audit.

The IRS most often audits taxpayers who find themselves on opposite sides of the spectrum. Taxpayers who earn less than $25,000 and high income taxpayers who earn an Adjusted Gross Income of $10 million dollars or more are most likely to get audited.

Businesses that claim clean energy credits may also face a higher risk of audit if the IRS believes taxpayers are incorrectly claiming these tax credits.

The IRS has two main methods for choosing taxpayers for audit:

• Random: The IRS randomly selects thousands of returns each year. As part of its National Research program, the IRS is able to track overall compliance.
• Computerized Screening Techniques: The IRS compares returns against national norms. When returns are outside the norm, they are flagged for audit.

Some of the common red flags audit screening might pick up include:

• Reporting High Income
• Underreporting Income
• Taking Large Charitable Donations
• Failing to Report Foreign Income
• Home-Office Deduction
• Claiming Rental Losses
• Not Filing a Tax Return, Especially When There Is a High Income
• Business Use of an Automobile
• Filing Schedule C for Sole Proprietors
• Taking an Early Payout From an IRA or 401(K)
• Acquiring Cryptocurrency
• Reporting Business Losses
• Taking an Alimony Deduction
• Deducting a Large Amount of Business Expenses
• Operating a Business With a Lot of Cash Transactions
• Claiming an Investment Tax Credit (ITC)
• Claiming a Clean Energy Tax Credit
• Claiming a Tax Credit for a Conservation Easement

While they expect accuracy in all areas of tax reporting, the IRS is especially detailed in these areas. They require accurate figures and sufficient supporting details. If you have included any of these in your tax return, it’s best to have accurate documentation and precise justification.

In general, the IRS has three years from the date you filed your return to audit it. However, if they suspect a substantial error, specifically a large amount of underreported income, they can go back up to six years. If they can show fraud, there is no limit to how far back they can go.