How Does the IRS Tax Audit Process Work?

An IRS tax audit involves a review of an individual’s or organization’s financial records and tax returns. Its purpose is to ensure accuracy and compliance with federal tax laws. Audits are a routine part of the Internal Revenue Service’s efforts to confirm that the correct amount of tax has been reported and paid.

What Triggers an Audit

The Internal Revenue Service (IRS) employs various methods to select tax returns for examination. The Discriminant Function System (DIF) scoring is a computer-generated numerical rating that assesses the likelihood of errors or discrepancies in a tax return. A higher DIF score indicates potential issues, leading to IRS review.

Discrepancies in information reported to the IRS are common audit triggers. The IRS cross-references data from various sources, such as W-2 and 1099 forms, against the income reported on a tax return. A mismatch, such as wages reported on a W-2 not aligning with declared income, can prompt an audit.

Certain financial behaviors and tax return entries also raise flags. Claiming large deductions relative to income, especially if they reduce taxable income, can attract IRS attention. This includes charitable contributions disproportionate to reported earnings or excessive business expenses. Consistently reporting business losses may also lead the IRS to question the legitimacy of the business, increasing the likelihood of an audit.

Different Types of Audits

The IRS conducts audits through several methods, varying in scope and location. The type of audit depends on the complexity of the issues being examined and the information required.

The most common type is a correspondence audit, conducted entirely by mail. These audits focus on specific issues, such as verifying a deduction. The IRS sends a letter requesting additional documentation, and the taxpayer responds by mail.

A more detailed examination is the office audit, which requires the taxpayer to visit a local IRS office. These audits are for issues more complex than those handled by mail, often involving a broader review of income, expenses, or itemized deductions. During an office audit, the taxpayer meets with an IRS agent to provide documents and answer questions.

The most comprehensive examination is the field audit. An IRS agent conducts this audit at the taxpayer’s home, business, or the office of their representative. Field audits are for intricate individual or business returns, involving an in-depth review of numerous financial records and multiple aspects of the return.

Understanding the Audit Process

Upon selection for an audit, the IRS initiates the process by sending a notification letter by mail; the IRS does not contact taxpayers about audits by phone or email. This initial notice specifies the tax year(s) under review and outlines the items or issues the IRS intends to examine. The letter also details the requested documents and provides a deadline for the taxpayer’s response.

After receiving the audit notice, the taxpayer should review the requested information and gather all relevant documents. These include receipts, invoices, bank statements, and other financial records that substantiate the income, deductions, or credits claimed. Provide only the specific documents requested by the auditor, ensuring they are organized and legible.

For office or field audits, the process involves direct interaction with an IRS auditor. During these meetings, the taxpayer or their representative presents the gathered documentation and answers questions regarding the tax return. Be direct and factual in responses, providing clear explanations without volunteering unnecessary information. The auditor will review the provided information, may ask follow-up questions, and formulate findings.

What Happens After an Audit

Once the IRS auditor completes their review, the examination phase concludes with a determination of the tax return’s accuracy. There are three possible outcomes following an audit. The most favorable result is a “no change” letter, indicating the IRS agrees with the original tax return as filed, and no adjustments are necessary.

If the auditor identifies discrepancies and proposes changes to the tax liability, the taxpayer can either agree or disagree. If the taxpayer agrees with the proposed adjustments, they will sign an agreement form and pay any additional tax, interest, or penalties owed. This resolves the audit and closes the case.

Should the taxpayer disagree with the auditor’s proposed changes, the case becomes “unagreed.” The IRS will issue a 30-day letter, which outlines the proposed adjustments and informs the taxpayer of their right to appeal the findings. The taxpayer has 30 days from this letter’s date to file a protest with the IRS Office of Appeals, an independent body within the IRS that aims to resolve tax disputes without litigation. If an agreement is not reached at the Appeals level, or if the taxpayer chooses not to pursue an appeal, the IRS will issue a Notice of Deficiency, often referred to as a 90-day letter. This notice provides the taxpayer with 90 days to petition the U.S. Tax Court if they wish to dispute the proposed tax liability before paying it.