How an IRS Audit Works and What You Need to Do

An IRS audit involves an examination of an individual’s or organization’s financial records and tax returns. This process verifies compliance with federal tax laws. Receiving an audit notice does not automatically imply wrongdoing. It is a routine procedure the Internal Revenue Service undertakes to uphold tax regulations.

Reasons for an IRS Audit

The Internal Revenue Service selects tax returns for audit based on various factors. A common reason involves mismatches between information reported by third parties, such as employers or financial institutions, and the figures stated on a tax return. For example, if a Form W-2 or Form 1099-NEC shows income not fully reported, it can trigger an audit.

Returns with higher incomes or complex financial situations, including substantial deductions or business income and losses, may face increased scrutiny. The IRS compares returns against similar ones using statistical models to identify deviations. Certain deductions or credits, such as the Earned Income Tax Credit (EITC) or claims for home office expenses, are frequently reviewed due to their susceptibility to errors or improper claims.

Self-employment income reporting receives particular attention, as the IRS seeks to ensure both income and expenses are accurately stated. Unusually large or consistent business losses reported year after year can prompt an examination, as can substantial charitable contributions relative to income.

Types of IRS Audits

The IRS conducts audits through several distinct methods, tailored to the return’s complexity and issues.

The simplest is a correspondence audit, conducted entirely by mail. The IRS requests specific documentation to verify items like deductions, credits, or income. The taxpayer receives a letter detailing the requested information and instructions on how to submit it.

More complex issues may lead to an office audit, where the taxpayer meets with an IRS auditor at a local IRS office. These audits focus on specific items or sections of the tax return, such as significant medical expense deductions or rental income and expenses. The auditor will review the taxpayer’s records and ask questions during the meeting.

The most comprehensive type is a field audit, which occurs at the taxpayer’s home, business location, or the office of their tax representative. Field audits are reserved for complex individual returns, small businesses, or corporations. An IRS revenue agent will conduct a detailed examination of various financial records and business operations, often spanning multiple tax years.

Preparing for an IRS Audit

Receiving an audit notice from the Internal Revenue Service requires careful preparation. First, thoroughly read the IRS audit letter to understand the specific tax years and particular items under examination. This notice will outline the documentation the IRS expects to review.

Next, gather all relevant documentation. This includes income records such as Forms W-2, Forms 1099, and Schedule K-1s. For claimed deductions and credits, compile all supporting expense receipts, invoices, canceled checks, and bank statements.

Gather prior tax returns and any supporting schedules or worksheets related to the audited years. Organizing these records methodically makes them easily accessible. This streamlines the review process for both the taxpayer and the auditor.

Before any interaction with the IRS, review your original tax return alongside the gathered documentation. This comparison helps identify any discrepancies or areas requiring clarification, allowing you to anticipate potential questions. Understanding your own filing position thoroughly can prevent misunderstandings.

Seeking professional assistance from a qualified tax professional, such as a Certified Public Accountant (CPA), an Enrolled Agent (EA), or a tax attorney, is recommended. These professionals can interpret the audit notice, advise on necessary documentation, and represent you during the audit proceedings.

Navigating the Audit Process

Once all documentation is gathered and organized, interaction with the IRS begins. The IRS initiates contact through a formal letter, detailing the specific tax issues and requesting a response within a set timeframe, usually 30 days. The notice provides instructions on how to proceed: by mail, online, or in-person.

For correspondence audits, you will submit the prepared documents by mail to the address provided in the IRS letter. Send copies, not originals, and keep a complete set of records for your own files, along with proof of mailing. If the audit is an office or field audit, the letter will specify a date and time for an interview, or provide contact information to schedule one.

During an office or field audit interview, your tax representative, if you have one, can attend and speak on your behalf. When answering questions from the auditor, be truthful and concise, providing only the information specifically requested. Avoid volunteering additional details or opinions beyond what is directly asked, as this can inadvertently broaden the scope of the audit.

The auditor will review your submitted documents and may ask follow-up questions to clarify entries or substantiate claims. They will then present their findings, which may include proposed adjustments to your tax liability. Understand these findings and ask questions if anything is unclear before making any decisions. Maintaining professional and clear communication throughout the process can contribute to a smoother resolution.

After the Audit

Upon completion of the audit examination, the Internal Revenue Service will inform you of the findings, with several possible outcomes.

The most favorable outcome is a “no change” result, meaning the IRS agrees with your original tax return. You will receive a formal letter confirming this outcome.

If the IRS proposes adjustments to your tax liability and you agree with their findings, this is an “agreed change.” You will be asked to sign Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment. Signing this form allows the IRS to assess the additional tax due immediately, and it stops the accumulation of interest on the additional tax. Payment arrangements can then be made with the IRS.

Should you disagree with the IRS’s proposed changes, this becomes a “proposed change (disagree)” situation. You will receive a 30-day letter, which explains your right to appeal the decision within 30 days to the IRS Office of Appeals. This office offers an independent review, aiming to resolve disputes without litigation.

If an agreement cannot be reached at the Office of Appeals, or if you choose not to appeal, the IRS will issue a 90-day letter, also known as a Statutory Notice of Deficiency. This notice gives you 90 days to petition the U.S. Tax Court if you wish to dispute the deficiency in court. If additional tax is determined to be due, the IRS will provide instructions on how to make payments, including options for installment agreements if you cannot pay the full amount immediately.