How Should You Respond to an Audit Notice From the IRS?

Receiving an audit notice from the IRS can be a stressful experience for any taxpayer. This communication informs you that your tax return is under review, potentially leading to adjustments in your reported income or deductions. It’s crucial to approach the situation with a clear plan and informed steps.

Notice Format and Content

An IRS audit notice, such as a CP2000 or Letter 2205, identifies the tax year under review and highlights specific discrepancies, such as mismatches in reported income or deductions. It includes a response deadline, typically 30 days from the notice date, and specifies the required documentation, such as W-2 forms or receipts. The IRS selects returns for review using algorithms that flag deviations from norms. The notice also provides contact information for the assigned agent, allowing you to seek clarification. While the notice may propose adjustments to your tax return, these are not final and serve as a starting point for resolution.

Common Factors Leading to an Audit

Audits often stem from discrepancies between your reported income and third-party data, such as W-2s or 1099s. The IRS also flags unusual deductions, such as charitable contributions that exceed typical income percentages. Self-employed individuals and small business owners are at higher risk due to income variability and commonly claimed deductions, such as those for home offices or vehicles. Cash-intensive businesses face additional scrutiny. Keeping thorough records and adhering to IRS guidelines can help reduce audit risks.

Planning Your Response

When you receive an audit notice, review the letter carefully to understand the scope of the inquiry. Gather all required documentation and prepare an organized response. Consulting a CPA or tax attorney can be highly beneficial, especially for complex issues, as they can interpret IRS regulations and ensure your response is thorough and accurate. Align your documents with the IRS’s focus areas, including any explanatory notes or references to tax codes.

Documents You May Need

Income Documentation

Income documentation verifies the amounts reported on your tax return. Employees should have W-2 forms, while contractors need 1099 forms. Partnerships or S corporation income is reported on K-1 forms. Self-employed individuals should maintain detailed records, such as invoices and bank statements. For foreign income, include forms like 2555 or 1116 to support exclusions or credits. Ensure all documents match the figures reported on your return.

Bank and Credit Card Statements

Bank and credit card statements provide a record of income and expenses. For business expenses, these statements may be requested to confirm payments. Annotate transactions to link them to receipts or invoices, which can simplify the audit process. Reconciling statements with financial records prepared under Generally Accepted Accounting Principles (GAAP) can further validate your numbers.

Expense Records

Expense records substantiate the deductions claimed on your return. Receipts and invoices should meet the substantiation requirements outlined in the Internal Revenue Code, detailing the amount, time, place, and purpose of each expense. For home office deductions, you must prove exclusive and regular use of the space for business activities, as described in IRS Publication 587.

Consequences of Non-Response

Ignoring an IRS audit notice can result in significant financial and legal consequences. The IRS may issue a Notice of Deficiency, or “90-day letter,” proposing changes to your tax return. Failure to respond allows these changes to become final, leading to collection actions like wage garnishments or bank levies. Interest on unpaid taxes accrues daily, and penalties can increase your liability by up to 25%. Non-response may also harm your credibility with the IRS, potentially broadening the scope of the audit.

Options if You Dispute the Findings

If you disagree with the IRS’s conclusions, request a meeting with the auditor or their supervisor to present additional documentation or clarify any misunderstandings. If this does not resolve the issue, file a formal appeal with the IRS Office of Appeals, including a written protest that outlines your position and supporting evidence. For disputes involving less than $25,000, you may qualify for a “small case request.” Should the appeal fail, you can escalate the matter to the U.S. Tax Court, the Court of Federal Claims, or a U.S. District Court. Consider alternative dispute resolution methods, such as mediation or arbitration, for a potentially quicker outcome.