What Does It Mean If You Get Audited?

An audit by the Internal Revenue Service (IRS) involves a thorough review of an individual’s or organization’s financial records and tax returns. Its primary purpose is to verify the accuracy of reported income, deductions, credits, and other financial data, ensuring compliance with federal tax laws. Receiving an audit notice does not automatically imply wrongdoing; it signifies that the IRS seeks to confirm the information provided.

Understanding What an Audit Is

An IRS audit examines a taxpayer’s financial information and tax returns to verify reported data and adherence to tax laws. The IRS conducts these examinations to ensure taxpayers report the correct tax liability. This process helps maintain public confidence in the tax system by promoting fairness.

Audits are a standard part of tax administration, serving to uphold the integrity of the tax system. The scope of an audit can vary significantly, from reviewing a single item to a comprehensive examination of the entire return. While the goal is to confirm accuracy, an audit can sometimes reveal a taxpayer overpaid, leading to a refund.

How Audits Are Selected

The IRS employs various methods to select tax returns for audit, aiming to identify those with potential errors or discrepancies.

One primary method involves the Discriminant Inventory Function (DIF) system. This computer scoring system assigns a score to each tax return based on statistical formulas, indicating the likelihood of an error or underreported income. Returns with higher DIF scores are flagged for further review.

Information matching is another common selection technique. The IRS cross-references data reported by third parties, such as employers (Form W-2) and banks (Form 1099-INT), with the income and deductions reported on a taxpayer’s return. Discrepancies between these sources can trigger an audit.

Audits can also arise from related party examinations. If a business partner or other entity with whom a taxpayer has financial dealings is audited, the taxpayer’s return might also be selected due to interconnected transactions. Furthermore, the IRS may initiate specific compliance campaigns focusing on particular industries or tax issues identified as having a higher rate of non-compliance.

A small percentage of returns are selected randomly as part of the National Research Program. These random audits help the IRS gather data to measure overall compliance levels and update its audit selection models. While random selection occurs, most audits are triggered by specific indicators of potential errors.

Different Types of Audits

IRS audits are conducted in several ways, each differing in scope and the level of interaction required from the taxpayer. The most common type is the correspondence audit.

Correspondence audits are conducted entirely by mail and typically focus on one or two specific items on a tax return, such as missing documentation for a deduction or a discrepancy in reported income. The IRS will send a letter requesting clarification or additional supporting documents. These audits are often resolved by mailing the requested information.

Office audits represent a more involved examination and are conducted at a local IRS office. These audits are usually broader in scope than correspondence audits, often requiring the taxpayer or their authorized representative to bring a range of financial documents for review. The IRS auditor will typically ask questions about specific income sources, deductions, or credits.

Field audits are the most comprehensive type of examination. These audits occur at the taxpayer’s home, place of business, or the office of their tax professional. Field audits are generally reserved for complex business returns or individuals with significant financial activity. An IRS agent will conduct an in-depth review of financial records and accounting systems.

Initial Steps After Receiving a Notice

Upon receiving an audit notice from the IRS, carefully read the entire notice to fully understand its contents. This letter will specify the type of audit (correspondence, office, or field), the tax year(s) under examination, and the particular items on the return being questioned.

Understanding the scope of the audit is important, as the notice will outline what the IRS is looking for. Identify the specific income, deductions, or credits under scrutiny. This helps focus efforts on gathering only the necessary information.

Gather all relevant financial records and supporting documentation pertaining to the questioned items. This includes receipts, invoices, bank statements, and any other paperwork that substantiates the information reported on the tax return. Organizing these documents thoroughly is beneficial.

For complex audits, considering professional assistance from a qualified tax professional, such as a Certified Public Accountant (CPA), Enrolled Agent, or tax attorney, is advisable. These professionals can help interpret the notice, organize documents, communicate with the IRS, and represent the taxpayer. Ignoring an audit notice can lead to negative consequences, including disallowed deductions and additional tax assessments.

Navigating the Audit Process

Once initial preparation is complete, the audit process moves into interaction with the IRS. For correspondence audits, submit requested documents by mail within the specified deadline. In office or field audits, the initial contact involves a scheduled meeting where the taxpayer or their representative will present the gathered information to the IRS auditor.

During any interaction, provide only the requested information and documentation. Volunteering unnecessary details can unintentionally broaden the audit’s scope. Clear, concise responses are most effective.

Communication with the auditor should remain professional. The auditor will review provided documentation, ask follow-up questions, and may request additional information. Taxpayers should ensure all responses are accurate and supported by their records.

After reviewing all information, the auditor will present preliminary findings or proposed adjustments. The taxpayer has an opportunity to discuss these findings, provide further explanations, or offer additional supporting documents. This discussion clarifies misunderstandings or presents arguments against proposed changes.

If the taxpayer agrees with the auditor’s findings, they can accept the adjustments. If there is disagreement, express concerns and seek further discussion before the audit concludes.

Potential Outcomes and Next Steps

An IRS audit can conclude with several possible outcomes. The most favorable result is a “no change” outcome, meaning the IRS accepts the return as filed, and no adjustments are made.

Alternatively, the auditor may propose changes to the tax return. These proposed adjustments could result in additional tax owed, a refund due to the taxpayer, or changes to other items on the return. The auditor will explain these proposed changes and their basis.

If a taxpayer agrees with the proposed changes, they will typically sign an agreement form, such as Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment. If additional tax is owed, payment arrangements will be made. If a refund is due, the IRS will process it accordingly.

However, if a taxpayer disagrees with the auditor’s findings, they have the right to appeal the decision. The IRS Independent Office of Appeals offers an impartial forum for resolving tax disputes without litigation. This office is separate from the IRS compliance functions.

Should an agreement not be reached through the appeals process, or if the taxpayer chooses not to appeal, the IRS may issue a Statutory Notice of Deficiency, often referred to as a “90-day letter.” This formal notice asserts the IRS’s determination of additional tax owed and provides the taxpayer 90 days to petition the U.S. Tax Court if they wish to dispute the deficiency in court without first paying the amount.