What You Need to Know About IRS Tax Audits

There are several different types of IRS tax audits, and any audit can result in interest, fines, and penalties being assessed after the audit, so each audit type must be taken seriously.

A correspondence audit is conducted strictly by letter. The IRS sends a notification requesting clarification or documentation relating to specific items or issues. This is the least severe tax audit, and if you have the documentation to back up the deduction or item on your tax return, you may be able to handle this type of audit on your own. However, if you cannot substantiate the claim, you should obtain some help since interest and/or other penalties are typically imposed if the IRS determines that the deduction is illegitimate.

An office audit is conducted at an IRS office. You will be asked to attend the audit and to provide specific documents outlined in the audit notice.

A field audit is conducted at your home, or, if it is a business audit, at your place of business. The field audit is the broadest type of audit, and the IRS can request to see more documents than in the other types of audits. Usually, a field audit indicates that the IRS is looking for something specific, often related to business income.

The IRS also conducts random audits. Since these audits are random, the IRS is not looking for anything specific, but your entire return will be reviewed.

Under most circumstances, the IRS can conduct an audit within three years of the date of filing of the return, but back taxes can be collected for up to 10 years. This means that if an audit of one year’s return uncovers an error in payment of taxes on returns that were filed more than three years before the audit was conducted, the back taxes on those previous returns – up to 10 years – can also be collected.

There are exceptions to the three year limit on IRS audits which extends that timeframe, including fraud, failure to file a tax return, and significant underreporting of income, which allow the IRS to conduct the audit more than three years after the audit has been filed.

The IRS will audit you for a number of reasons, including random sampling, computerized screening, and comparison of your return with information received by the IRS from other sources. For example, if something on your return does not conform with information the IRS has received from your employer, it might trigger an audit.

Failure to report income is another major reason for IRS audits. Every dollar of income received, including income received as an independent contractor, must be reported to the IRS.

Deductions can also lead to an audit. Red flags that trigger IRS audits are related to business expenses, such as business travel, entertainment, and meals. Other deductions, including charitable donations, depreciation, and dependent exemptions may also trigger an audit.

Cash businesses are also frequent targets for audits, since there is a perception that many cash-based businesses typically do not report all income received. Similarly, home-based businesses are often heavily scrutinized when a deduction is taken for space within the home that is dedicated to the business, since the IRS requires that if this deduction is taken, the space must be used “regularly and exclusively” for business purposes, and cannot be also used for personal reasons.

If you have been audited in the past or receive notice that you are currently under audit, you should talk to an experienced tax lawyer, who can help guide you in the proper preparation of your return and going through an audit. 

Also, check out our article: What to Do Before, During, and After an IRS Tax Audit.