We’ve all heard the horror stories. A friend of a friend makes a small mistake in preparing their tax return, and the next thing they know the long bureaucratic arm of the IRS is knocking at their door.
What ensues is a living nightmare of paperwork and probing questions.
We hope you never get audited, but if you do, it’s better to be informed. This is the image we have of an IRS audit, but how accurate is it? What really happens during a tax audit? Why does it happen? What can you do to prepare? In today’s article, we’ll tackle these questions. Read on to find out more.
What Is an Audit?
Let’s begin with the official IRS definition of an audit:
“An IRS audit is a review/examination of an organization’s or individual’s accounts and financial information to ensure information is reported correctly according to the tax laws and to verify the reported amount of tax is correct.”
This definition encompasses a huge range of scenarios, from a regular W-2 employee to a multinational corporation. Consequently, the IRS explanation of the audit process is somewhat generic. It has to be, in order to provide an overview of the myriad possible audit scenarios.
What’s more important to understand is all the things an audit is not. An audit is not:
- A criminal investigation or accusation of a crime. The IRS performs audits to ensure that you have filed your taxes in accordance with US law. They just want to make sure that you’re doing everything correctly. While the IRS can conduct criminal investigations if they suspect tax fraud, this is a separate process that special IRS agents handle. Auditors can recommend criminal investigations based on their findings, but they do not perform them.
- An indication that you filed your taxes incorrectly. The IRS initiates the audit process based on random sampling and computer screening designed to detect deviations from “norms” that they establish as part of their National Research Program. Just because your tax return looks irregular to the IRS software, that doesn’t necessarily mean it’s incorrect.
- Cause for fear and alarm. It’s natural to be afraid when you get audited but provided that you have filed your taxes in good faith and without criminal intent, you have nothing to worry about. Ultimately, what the IRS cares about is that you file and pay your taxes lawfully and correctly. If you just made an honest mistake, you may have to pay back taxes or a penalty, but you aren’t going to go to jail.
Now that we’ve covered what an audit is (and isn’t), let’s look at what happens during the audit process.
What Happens During the Audit Process?
Much of the fear surrounding audits comes from a general ignorance of what happens during an audit. The popular vision is of a squadron of IRS auditors dragging you out of bed in the middle of the night and shaking you down for all your financial records. The reality is far less dramatic.
Step 0: Know Your Rights
Before we discuss any audit process details, you need to know your rights as a taxpayer. In all tax matters, the IRS notes that you have the following rights:
- “A right to professional and courteous treatment by IRS employees.”
- “A right to privacy and confidentiality about tax matters.”
- “A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.”
- “A right to representation, by oneself or an authorized representative.”
- “A right to appeal disagreements, both within the IRS and before the courts.”
For more information, consult Publication 1, Your Rights As A Taxpayer.
Step 1: Notification
First, you should know that the IRS will always notify you of an audit via mail. The IRS states explicitly that this is the only way they will notify you of an audit. The will never notify you via telephone or other means (although they may contact you via phone about other tax-related matters).
If you receive an email, phone call, or other non-postal communication notifying you of an IRS audit, don’t respond. You can report IRS-related phishing by emailing email@example.com. For more information on how to identify tax phishing scams and how to report them, visit the IRS Report Phishing page.
Step 2: Scheduling the Interview
Once you’ve received notice of an audit, the IRS will conduct it either via mail or in-person interview. Depending on the nature of the audit, it may occur either at an IRS office, your home, your place of business, or at your accountant’s office. The letter from the IRS will contain specific instructions about where they will conduct your audit.
Note: If the IRS conducts the audit by mail and requests more documents than are practical for you to send, you may request an in-person interview. Contact information for this request is included with your audit notification letter.
Step 3: Records the IRS May Request
Once you’ve arranged the interview, you’ll need to gather the necessary records. The IRS will specify which documents you need to provide. According to their page IRS Audits: Records We Might Request, here are some documents they could ask for:
- Canceled checks
- Legal papers
- Loan agreements
- Logs or diaries
- Medical and dental records
- Theft or loss documents
- Employment documents
- Schedule K-1 (Form 1065)
If the IRS is conducting the audit via mail, always mail copies of the records, never originals. For more information on how to keep accurate financial records, visit the IRS Recordkeeping page.
Step 4: The Audit Process
The details of how the IRS auditor will conduct the audit vary from case to case. In general, they will review your financial records and compare them with possible discrepancies in your tax return. In certain cases, the auditor will follow industry-specific Audit Technique Guides.
These guides are too numerous to discuss here, but they cover everything from audit considerations specific to art galleries to indoor tanning services. If you’re a regular W-2 employee, these guidelines are unlikely to apply to you.
Sow how long does an audit take? Unfortunately, there’s no straightforward answer. The IRS states that the length of the audit depends on the following factors:
- The type of audit
- The complexity of the issues
- The availability of information requested
- The availability of both parties for scheduling meetings
- Your agreement or disagreement with the findings
The last factor can have an especially large effect on the length of the process, and it brings us to the next step: concluding the audit.
Step 5: Concluding the Audit
So you’ve survived the audit process. Now what? The IRS will conclude your audit in one of the following three ways:
- “No change: an audit in which you have substantiated all of the items being reviewed and results in no changes.”
- “Agreed: an audit where the IRS proposed changes and you understand and agree with the changes.”
- “Disagreed: an audit where the IRS has proposed changes and you understand but disagree with the changes.”
The first case needs no further discussion–you’ve lost some time and maybe a little sleep, but you don’t need to take any further action.
If you agree with the audit, then the auditor will ask you to sign an examination report or another similar document. This certifies that you agree with the findings. If the auditor determines that you owe money, you’ll need to arrange payment. Depending on your circumstances, you can either pay in full, petition to pay in installments or even delay the collection process.
If you disagree with the audit results, then you may request a conference with an IRS manager. You can also request mediation or file an appeal (assuming you’re still within the statute of limitations).
Take the Fear Out of Audits
Getting audited is never going to be a pleasant process, but it’s not the end of the world, and it doesn’t have to be scary. Now that you understand what happens when you get audited (as well as your rights as a taxpayer), you should have the confidence to face an audit with confidence if you ever find yourself undergoing one.
Of course, the best audit is one that never happens. To avoid getting audited to begin with, we suggest that you use quality tax preparation software. The right software will guide you through the tax filing process in a way that minimizes your audit risk, as well as providing you with an estimate of the odds that you’ll be audited.
To make choosing tax software easier, we’ve done all the hard work of reviewing and comparing the best tax software on the market. Check out our reviews here.
And to get fresh tax tips delivered to your inbox each week, subscribe to our newsletter. Thanks for reading!