What Does a Tax Audit Mean? How to Respond to the IRS

A tax audit represents an official examination of an individual’s or organization’s financial records and tax returns by the Internal Revenue Service (IRS). The primary objective of such an examination is to verify the accuracy of reported income, deductions, credits, and tax liability. Audits serve to ensure compliance with federal tax laws and regulations. Receiving an audit notice does not automatically imply that an error or wrongdoing has occurred on the tax return.

How Audits Are Initiated

The IRS employs various methods to select tax returns for audit, leveraging advanced data analysis. Discrepancies between information reported on a tax return and data received from third parties, such as W-2 or 1099 forms, are common triggers.

Unusually high deductions relative to an individual’s income level or significant changes in deductions from previous tax returns can also draw attention. The IRS utilizes computer programs to identify returns with a higher probability of error or noncompliance.

Some returns are selected randomly as part of the National Research Program (NRP). This program aims to gather data on taxpayer compliance and improve the IRS’s understanding of reporting behavior. Selection under the NRP does not indicate any specific issue with the taxpayer’s return but contributes to broader statistical analysis for tax policy and enforcement.

Understanding the Audit Notice

Upon receiving an audit notice from the IRS, it is important to carefully review its contents. Common notices include Letter 566 or CP2000, with CP2000 notices often indicating a mismatch between reported income and third-party information.

The notice will specify the tax year under examination and the particular items or issues being questioned. It will also outline the requested documentation, which may include receipts, bank statements, canceled checks, or other financial records. The notice provides a deadline for response, usually 30 days, and indicates the type of audit: correspondence, office, or field. Gathering and organizing all requested documents according to the notice’s specifications is an important preparatory step.

Responding to the Audit

Responding to an audit requires adherence to specific procedures based on the type of audit indicated in the notice. For a correspondence audit, conducted by mail, taxpayers must send only copies of requested documents, never originals. Use certified mail with a return receipt for proof of delivery and retain a complete set of all submitted materials.

An office audit requires the taxpayer to attend an in-person meeting at a local IRS office. For this meeting, all organized documentation supporting the contested items should be brought. Taxpayers have the option to be accompanied by a tax professional, such as an enrolled agent, certified public accountant, or attorney, who can represent them during the examination. During the meeting, providing clear, concise answers strictly to the questions asked by the auditor is recommended, avoiding extraneous information.

A field audit is the most comprehensive type, where an IRS agent visits the taxpayer’s home or place of business to examine records. Maintaining a professional demeanor and ensuring all documents are organized before the agent’s arrival is important. As with an office audit, professional representation can be beneficial, allowing the representative to handle most direct interactions. In all audit types, consistent communication, providing only requested information, and keeping detailed logs of all interactions are important.

After the Audit

Once the IRS completes its examination, there are several possible outcomes. If the auditor finds no changes are needed to the tax return, the audit concludes with a “no change” letter. This signifies that the taxpayer successfully substantiated all reviewed items.

If the IRS proposes changes to the tax liability, the taxpayer will receive an examination report, such as Form 4549, detailing adjustments, additional tax owed, and applicable penalties or interest. If the taxpayer agrees with these findings, they will sign an agreement form and proceed with payment arrangements if a balance is due. Signing this form waives the right to contest the decision in Tax Court.

Should the taxpayer disagree with the audit results, they will receive a “30-day letter,” which formally outlines the proposed changes and informs them of their right to appeal the decision within 30 days. This appeal can be made to the IRS Appeals Office, an independent forum within the IRS designed to resolve tax disputes without litigation. If an agreement cannot be reached at the appeals level, the IRS will issue a “90-day letter,” also known as a Notice of Deficiency, giving the taxpayer 90 days to petition the U.S. Tax Court.