How the IRS Examination Process Works

An IRS examination, commonly known as an audit, is a review of an individual’s or organization’s financial information to ensure it is reported correctly according to tax laws and to verify the amount of tax is accurate. Being selected for this process does not mean a taxpayer has made an error or been dishonest.

Many examinations are resolved without any change to the tax liability, and some even result in a refund to the taxpayer. The process is a standard part of tax administration designed to ensure fairness and compliance with the nation’s tax laws.

Selection for an IRS Examination

A primary tool is a computer program known as the Discriminant Function System (DIF). This system assigns a numeric score to each tax return by comparing it to norms derived from a statistical sample of similar returns. A higher DIF score indicates a greater probability of containing errors, flagging the return for a potential review by an IRS employee.

Another selection method is random sampling through the National Research Program (NRP). The IRS uses the NRP to gather data on taxpayer compliance, which helps update the DIF scoring formulas. Returns chosen under the NRP may undergo a more intensive review of each line item, as the goal is to collect accurate statistical data.

A taxpayer’s return may also be selected if it involves transactions with other individuals or businesses already under audit. For instance, if a business partner or an investor is being examined, the IRS may pull the returns of related parties to ensure consistency and accuracy across all associated filings.

Many examinations are triggered by the IRS’s third-party information matching program. The agency’s computers cross-reference the income reported on a tax return with documents filed by third parties, such as Form W-2 from employers and Form 1099s from banks. When a discrepancy is found between the taxpayer’s reported figures and third-party data, it automatically flags the return for review.

Types of IRS Examinations

The most common type is the mail audit, or correspondence examination. This audit is handled entirely through written correspondence, where the IRS sends a letter requesting documentation or clarification on specific items like itemized deductions or credits. The taxpayer responds by mailing the requested records, and the process is resolved without a face-to-face meeting.

An office audit, or office examination, requires the taxpayer or their representative to visit a local IRS office. The initial notification arrives by mail and will specify the issues under review and schedule an in-person appointment. The scope of an office audit is confined to specific areas of the tax return and often addresses issues too complex for correspondence.

The most comprehensive examination is the field audit. An IRS revenue agent conducts the audit at the taxpayer’s home, place of business, or accountant’s office. Field audits are generally for more complex tax returns, such as those filed by large corporations or individuals with substantial business operations. A field examination can be broad, potentially covering the entire tax return.

Preparing for the Examination

The first step in preparing for an examination is to carefully read the IRS notice, which specifies the tax year and issues under review. A common notice is the CP2000, which is not an audit but a proposal for adjustments based on mismatched information from third-party data. Understanding the scope of the examination from this notice is key to gathering the correct documentation.

With the issues identified, gather all relevant documentation. For income verification, this includes Forms W-2, 1099, K-1, and bank statements showing deposits. If business expenses are examined, collect receipts, invoices, and credit card statements that substantiate each deduction. For vehicle use, a detailed mileage log is required, while meal and travel expenses need receipts and records explaining the business purpose.

For itemized deductions, specific documentation is also required. Medical expense claims must be supported by receipts from providers and proof of payment. Mortgage interest and property taxes are substantiated with Form 1098 and statements from the local taxing authority. Charitable contributions require bank records or written acknowledgements from the charity, especially for larger donations.

Once collected, documents should be organized logically, such as by year and then by the issue outlined in the IRS notice. Making copies of all documents before sending them to the IRS is a recommended practice. This ensures you retain a complete set of the information provided for your own records.

It is beneficial to review your tax return for the year under examination. Re-familiarizing yourself with the figures and positions taken can help you understand the context of the IRS’s questions. This review can also help you or your representative anticipate follow-up questions and prepare clear explanations.

The Examination Procedure

The examination begins with the initial contact, either a response to a mail audit letter or attendance at a scheduled meeting. During this first interaction, the IRS examiner will outline the process, explain the specific issues being reviewed, and detail what information is needed. This meeting establishes the lines of communication for the examination.

When presenting information, provide only the documents specifically requested by the examiner. Submitting unsolicited records can unnecessarily broaden the scope of the audit. Having your documents organized and ready for review demonstrates cooperation and can make the process more efficient.

During interviews, answer the examiner’s questions truthfully and directly. Taxpayers should avoid speculating, guessing, or providing information that was not asked for. If an answer is unknown, it is appropriate to state that and offer to find the information if necessary. The goal is to be cooperative without introducing new areas of inquiry.

After the initial submission of documents, the examiner begins their review to verify the items on the tax return. The examiner may ask follow-up questions or issue an Information Document Request (IDR) for additional records. The taxpayer or their representative should respond to these requests promptly.

Throughout the process, taxpayers are protected by the Taxpayer Bill of Rights. This includes the right to professional treatment, privacy, and to know why the IRS is asking for information. A key protection is the right to representation, which allows a taxpayer to have a qualified professional, such as a CPA, attorney, or Enrolled Agent, represent them.

Concluding the Examination and Next Steps

After the examiner has reviewed all provided information, they will issue a report detailing their findings. The examination can conclude in one of three ways, each with distinct procedures and next steps for the taxpayer.

The most favorable outcome is a “no change” determination, where the IRS accepts the tax return as filed. The agency sends a letter stating this conclusion, and no further action is required from the taxpayer. This means the taxpayer successfully substantiated all items under review.

If the examiner proposes changes and the taxpayer agrees, this is an “agreed” case. The taxpayer will sign an agreement form, such as Form 4549, Income Tax Examination Changes, which details the adjustments. After signing, the taxpayer receives a bill for the additional tax, penalties, and interest and will need to make payment arrangements.

Should the taxpayer disagree with the proposed changes, the case is “disagreed.” The IRS then issues a “30-day letter,” which includes the examiner’s report and explains the right to appeal. The taxpayer has 30 days from the date on this letter to request a conference with the IRS Independent Office of Appeals, an impartial office that resolves tax disputes without litigation.