Your Guide to an IRS Tax Audit

Wrapping your head around your taxes can be difficult enough as it is. And getting audited can feel so much worse. But fret not! The IRS audits tax returns to verify if the information you’ve provided is correct. It doesn’t necessarily mean you’ve made errors or been dishonest, and it also doesn’t mean that you’re losing your refund or that you now owe the IRS. Basically, the IRS is double-checking your numbers.

Moreover, an IRS audit isn’t inherently sinister as long as you are telling the truth! And with a little guidance, you’ll come to grips with how an audit works and how best to protect yourself from tax issues. So, wipe that sweat from your brow, and let’s get started!

What is an IRS tax audit?

There are a lot of misconceptions about what an audit truly is and what to expect if you get audited. The IRS defines an audit as “a review/examination of an organization’s or individual’s accounts and financial information to ensure information is being reported correctly, according to the tax laws, to verify the amount of tax reported is accurate”.

In a nutshell, this means that the government wants to talk to you about a discrepancy in your income tax returns. They basically want to resolve a discrepancy between their understanding of what you should owe and what you reported.

Reasons the IRS would audit you

Very high or very low income

Those who report that they made no income and those who report income of over $500,000 have a higher chance of being audited.

Missed income

If you overlooked some income, the IRS could audit you. Make sure you remember all of your forms when you file your tax return, especially when it comes to W-2s.

Self-employment

If you are a freelancer or sole proprietor claiming many business deductions, the IRS could get suspicious.

Home-based business

Claiming home-office deductions is tricky because the rules are confusing. The IRS knows this, and you may get in trouble if you do it wrong.

Hobby vs. business

There are certain tax rules that determine the difference between a business and a hobby. Getting these rules wrong can mean receiving an audit. Your hobby doesn’t count as a business if you haven’t made a net profit in at least three of the past five years. For breeding horses, it’s 2 of the last 7 years.

Cash or assets in a foreign country

Foreign accounts, especially high-value ones, can trigger an audit.

Unusual amounts of cash

Large withdrawals, large deposits, and working in a mostly cash-based career may alert the IRS.

Investment income

Did you earn investment income that you forgot to file a 1099 for? This could get you audited.

Many itemized deductions

Filing an unusually large amount of itemized deductions can alert the IRS to possible suspicious activity.

Earned income tax credit (EITC) claim

This tax credit increases as your number of dependents increases. You can get a big refund for this, so the IRS likes to double-check it.

Too many losses on a Schedule C

For those who are self-employed and file a Schedule C form, the IRS may suspect you of deducting personal expenses as business expenses.

Math errors

This is a simple one. If you did your math wrong, the IRS will know.

Using rounded numbers

Are you reporting numbers that are “too perfect?” If numbers seem too rounded (e.g. $500, $10,000, $4,500) then they don’t seem real.

Random selection

Lastly, believe it or not, you get selected at random. Essentially, you're the winner of a very unfun lottery. There's no discrepancy or problem with your filing, per se. You’re just statistically unfortunate.

How an IRS audit works

Sometimes, the IRS will audit you without telling you by just reviewing your tax return again. If this isn’t the case, they will contact you directly in one of three ways.

Three types of audit notices

There are many reasons you could be audited, but only three types of audits you could receive:

Correspondence audit

The IRS sends you an audit letter.

Field audit

IRS agents can come to your place of business.

Office audit

You meet with an auditor at an IRS office for 2-4 hours.

What to do if you get audited

Once you receive an IRS tax audit notification and the initial wave of panic recedes, review your records for honest mistakes. If you knowingly falsified your return and aren't surprised by the audit, start by reading your rights as a taxpayer on IRS.gov. There are also additional steps you need to consider, such as hiring a tax attorney.

Similarly, if the IRS determines that you made a mistake on your return and you want to contest it, you have options beyond simply knowing your rights. The best advice is to consult with a tax resolution company. They will not only go over your liberties but can argue your case directly with the IRS. Provide all the necessary documents, so they can present an intelligent argument on your behalf.

Ultimately, securing representation may be essential in ensuring you get the most desirable resolution possible. It will also help to give you peace of mind that you can make it through your IRS tax audit with your finances and sanity intact.

After an audit

An audit will result in one of three things:

1. No changes to your tax return
2. Agreed-upon changes to your tax return
3. Changes to your tax return that you disagree with but have the option to appeal.

In some situations, you could face IRS penalties, especially if you owe back taxes. If you do appeal the IRS’s decision, you could end up in court. Additionally, a federal tax audit could affect your state tax return. All of this depends on your personal situation.

When your audit is settled, learn from your mistakes, but don’t be too hesitant to claim credits or tax deductions if they are legitimate. Make sure to always file on time (or early) and learn how to protect yourself if you ever have to go through an audit again.

How to protect yourself from an audit

To best protect yourself from an IRS tax audit, hire a qualified, well-rated tax professional to help with your taxes. This is the simplest and best way to ensure that everything is correct and the IRS gets all the information it needs from you. In addition, you can protect yourself by making sure you have all the right documentation saved.

Keep these documents in a safe place:

• Bills
• Tax returns filed in the past 3 years
• Evidence of claimed deductions
• Receipts for big purchases
• Any other supporting documentation

Even with these documents, getting professional help is the best course of action when it comes to filing taxes and dealing with audits. Save yourself the headache of a DIY solution or tax software – tax season isn’t the time to experiment!