What Happens When You Get Audited for Taxes?

A tax audit is a formal review conducted by a tax authority, such as the Internal Revenue Service (IRS), to verify the accuracy of a taxpayer’s financial information and tax returns. The purpose of an audit is to ensure that income, expenses, and deductions are reported correctly and that the appropriate amount of tax has been paid according to tax laws. Audits maintain the integrity of the tax system and ensure compliance.

Receiving an Audit Notice

Taxpayers typically receive notification of an audit through official mail, not by phone or email. Verify the authenticity of any such notice, as official communications always arrive as written correspondence.

Audits can be triggered for various reasons, with some selected randomly to ensure overall compliance. More commonly, audits arise from discrepancies identified through data matching programs, where information reported by third parties (like employers or financial institutions) does not align with the taxpayer’s return. Common triggers include unreported income, claiming excessive deductions disproportionate to income, or consistent business losses, especially for self-employed individuals filing Schedule C. Unusual business expenses, foreign bank accounts, or significant cash transactions can also raise red flags.

There are different types of audits, varying in scope and location. A correspondence audit is the most common, conducted entirely by mail to resolve simpler issues or request additional documentation. If issues are more complex, an office audit may be scheduled, requiring the taxpayer to visit a local tax authority office for an in-person interview. The most extensive type is a field audit, where an agent conducts the examination at the taxpayer’s home or business, often for complex business returns.

The Audit Process

Upon receiving an audit notice, carefully read the document to understand the requested information and the scope of the audit. The notice will specify the tax year(s) under review and the particular issues identified. Taxpayers typically have about 30 days to respond to an initial audit letter.

Organize and gather all relevant records and documentation. This includes receipts, invoices, bank statements, canceled checks, prior tax returns, W-2s, 1099s, and any other financial records that support the income, deductions, or credits claimed on the tax return. Proper documentation helps substantiate reported figures.

Communication with the auditor can occur through written correspondence for correspondence audits. For office or field audits, communication involves in-person meetings. Taxpayers have the right to professional and courteous treatment throughout the process.

During the review, the auditor examines submitted documents, asks questions, and verifies the information against tax laws. The auditor’s role is to ensure accuracy and compliance. Taxpayers have several rights during an audit, including the right to be informed, the right to privacy, and the right to retain representation by a qualified tax professional, such as a CPA, enrolled agent, or attorney.

Understanding Audit Outcomes

Once the audit review is complete, there are several possible outcomes. The most favorable result is a “no change” outcome, meaning the auditor found no issues and accepts the tax return as filed. In this scenario, the taxpayer’s tax liability remains unchanged.

Alternatively, the auditor may propose changes to the tax return. These proposed adjustments are detailed in an Examination Report, which outlines the findings, explains the proposed adjustments to income, deductions, or credits, and calculates any additional tax, interest, or penalties due. This report may also indicate a refund if the audit reveals an overpayment.

If the taxpayer agrees with the proposed changes, they can sign an agreement form, such as Form 870, consenting to the adjustments. Once signed, any additional tax, along with applicable interest, becomes due. This concludes the audit process.

If the taxpayer disagrees with the proposed changes, they will typically receive a 30-day letter. This letter explains the proposed adjustments, the taxpayer’s appeal rights, and grants a 30-day period to respond by either agreeing to the changes or submitting a protest to the IRS Office of Appeals. If no agreement is reached or no appeal is pursued within the 30-day timeframe, the tax authority will issue a Statutory Notice of Deficiency, also known as a 90-day letter. This formal notice allows the taxpayer 90 days (150 days if outside the U.S.) to petition the U.S. Tax Court to dispute the proposed deficiency without first paying the tax.

The Tax Appeals Process

If a taxpayer disagrees with the audit findings and receives a 30-day letter, they can pursue an administrative appeal. This process involves the IRS Independent Office of Appeals, which is separate from the IRS division that conducted the audit. The Appeals Office aims to resolve tax disputes fairly and impartially without litigation.

To initiate an appeal, the taxpayer must submit a written protest within the 30-day period specified in the letter. For less complex cases or those involving smaller amounts, a simpler form may be used instead of a detailed protest letter. The protest should clearly state the issues with which the taxpayer disagrees and provide supporting reasons and facts.

An Appeals conference is then scheduled, an informal discussion between the taxpayer (or their representative) and an Appeals Officer. During this conference, both sides present their arguments, and negotiations may occur to reach a mutually acceptable settlement. Appeals Officers can consider the “hazards of litigation,” evaluating the likelihood of either side prevailing if the case were to go to court.

Alternative Dispute Resolution (ADR) options, such as mediation, are also available through the Appeals Office. These programs provide a faster, more collaborative approach to resolving disagreements. Mediation involves a neutral facilitator helping the taxpayer and the tax authority reach a resolution.

If an agreement cannot be reached with the Appeals Office, or if the taxpayer bypasses the Appeals process after receiving a 90-day letter, the next step is to petition the U.S. Tax Court. This petition must be filed within 90 days from the date of the Notice of Deficiency. For disputes involving $50,000 or less for any single tax year, taxpayers may elect the small tax case procedure, which offers a less formal and faster resolution, though the decision cannot be appealed further. Filing a petition with the Tax Court postpones the requirement to pay the disputed tax until the case is decided.