What Is a Field Audit and How Does It Work?

A field audit is one of the most thorough tax examinations conducted by the IRS or state tax authorities. Unlike mail or office audits, an auditor visits a taxpayer’s home, business, or accountant’s office to review records in person. These audits focus on complex financial situations requiring closer scrutiny.

When It May Be Initiated

A field audit is triggered when tax authorities identify discrepancies, unusual deductions, or inconsistencies that cannot be resolved through a basic review. Large income fluctuations, excessive business expenses, or repeated losses on a Schedule C can raise red flags. The IRS uses the Discriminant Function System (DIF) to score tax returns based on potential errors, and a high DIF score increases the likelihood of an audit.

Certain industries and professions are more likely to face field audits due to the nature of their income reporting. Cash-intensive businesses such as restaurants, salons, and convenience stores often draw attention since cash transactions are harder to track. Self-employed individuals and independent contractors who claim deductions for home offices, travel, or meals are also subject to additional scrutiny. Businesses with a high volume of 1099 payments are monitored for potential misclassification of employees as independent contractors.

Past audit history can also play a role. If a taxpayer has been audited before and similar issues appear in subsequent filings, a more in-depth examination may be conducted. Third-party reporting discrepancies—such as mismatches between W-2s, 1099s, or bank records—can also prompt an audit, as the IRS cross-references these forms with tax returns to identify inconsistencies.

Advance Notice and Preparation

Once a field audit is scheduled, the taxpayer receives a formal notice outlining the scope of the examination, the tax years under review, and the specific records requested. The IRS typically issues this notice via Letter 2205-A or 2205-B, while state tax agencies follow similar procedures.

Preparation involves reviewing the relevant tax returns and organizing supporting documentation. Commonly requested records include general ledgers, bank statements, invoices, payroll records, and depreciation schedules. If business income is under review, reconciling reported revenue with financial statements and third-party payment records, such as 1099-K forms, is crucial. Auditors compare reported figures with external data sources, including financial institutions and vendor records.

Engaging a tax professional can help mitigate risks. Certified Public Accountants (CPAs), Enrolled Agents (EAs), or tax attorneys can review the audit notice, identify potential issues, and develop a response strategy. They can also communicate with auditors to ensure responses are accurate and do not raise further concerns. If records are incomplete, professionals can advise on alternative forms of substantiation, such as affidavits or reconstructed financial statements.

The On-Site Review

Once the auditor arrives, they may begin with an interview to clarify business operations, income sources, and accounting methods. This helps them understand how records are maintained and whether internal controls ensure accurate reporting. If a business is involved, the auditor may tour the premises to verify operations, assess inventory, or evaluate fixed assets.

During the review, financial transactions are examined for signs of underreported income or improper deductions. If cash transactions play a significant role, the auditor may analyze bank deposits, conduct a net worth analysis, or use industry benchmarks to estimate expected revenue. For businesses with inventory, cost of goods sold calculations are scrutinized to ensure they align with reported sales and purchases. Discrepancies in inventory valuation methods, such as FIFO or LIFO, can lead to adjustments.

Third-party verification may be necessary. The auditor might contact vendors, clients, or financial institutions to confirm reported figures. If payroll expenses are under review, they compare employee records with state unemployment filings to ensure wages and tax withholdings match reported amounts. Worker classification is also evaluated, as misclassification can result in payroll tax liabilities and penalties.

Common Documents Examined

Auditors rely on financial records to verify reported income and deductions. Bank statements are reviewed to track deposits and withdrawals, identifying unreported revenue or personal expenses improperly deducted as business costs. If discrepancies arise, auditors may request explanations or supporting documents, such as loan agreements or inter-account transfers, to distinguish taxable income from non-taxable sources like gifts or inheritances.

Expense receipts and invoices are scrutinized to ensure deductions comply with IRS guidelines, which require business expenses to be both ordinary and necessary. Vehicle expenses must be supported by mileage logs detailing dates, destinations, and business purposes. Travel and entertainment costs require itemized receipts, and expenditures over $75 generally need additional documentation. If depreciation is claimed, auditors examine fixed asset ledgers and Form 4562 to confirm compliance with applicable recovery periods.

Taxpayers claiming credits, such as the Research & Development Tax Credit, must provide detailed project documentation, including payroll records for qualifying employees and records of experimentation processes. Similarly, for the Earned Income Tax Credit, proof of earned income, such as pay stubs or employment contracts, is required.

What Happens After the Review

Once the on-site portion of the audit is completed, the auditor analyzes the findings to determine whether adjustments to the tax return are necessary. If errors or omissions are found, additional tax liability, including penalties and interest, is calculated. The IRS typically applies a failure-to-pay penalty of 0.5% per month on unpaid taxes, while accuracy-related penalties can add 20% to the amount owed if negligence or substantial understatement is found.

The taxpayer is presented with the audit findings in a formal report outlining any proposed changes. If they agree, they can sign Form 4549, the Income Tax Examination Changes agreement, and arrange for payment or an installment plan. If they disagree, they can provide additional documentation or explanations to dispute the findings. This can be done informally with the auditor or by requesting a meeting with the auditor’s supervisor. If a resolution is not reached, the taxpayer can file a formal appeal with the IRS Office of Appeals within 30 days. If disputes remain unresolved, legal action through the U.S. Tax Court may be necessary.