How to Survive an IRS Audit? Preparation!
Just the simple phrase, “IRS audit,” can be enough to trigger anxiety. For individuals and businesses alike, the thought of a relentless examination of your financial records with the threat of potential penalties looming overhead may send shivers down your spine.
However, if you’re facing this prospect, the first important step is: Don’t panic.
While an IRS audit may seem intimidating (and the process can be stressful and confusing), it shouldn’t be a nightmare. With the proper knowledge, preparation, and approach, you can confidently navigate the audit process and minimize potential negative outcomes.
In this post, we’ll explore valuable insights and practical tips to help you understand why you may be under audit, what to expect from the process, and how to prepare for the audit to maximize your chances for a favorable outcome.
Read on to empower yourself to face the challenge of an IRS audit with confidence.
What causes you to get audited by the IRS?
Being under audit can feel like being under investigation. However, it’s important to remember that an audit does not imply suspicion of criminal activity.
An audit is more of an examination. The purpose can be as simple as confirming accuracy or fixing unintentional errors.
- One common trigger is discrepancies or inconsistencies in your tax return. When the numbers reported on your return don’t align with the information the IRS has received from other sources, such as employers, financial institutions, or third-party reporting agencies, it can raise a red flag.
- Another factor that can increase audit risk is engaging in certain activities or industries the IRS considers more prone to non-compliance. For example, operating a cash-intensive business, such as a restaurant or a self-employed profession where cash transactions are common, can raise suspicions of underreporting income. Similarly, claiming excessive deductions or credits, especially those outside the norm for your industry or income level, can attract scrutiny.
- Additionally, statistical factors play a role in the selection process. The IRS uses computer algorithms to analyze tax returns and identify anomalies that deviate from the norm. This may include comparing your return to statistical averages or specific industry benchmarks. Your return may be flagged for further review if it falls outside the expected range.
Remember: Being selected for an audit does not necessarily mean you have done anything wrong. The IRS also conducts random audits as part of its compliance efforts.
What to expect during an IRS audit
The audit process begins with a formal notification from the IRS, usually through a letter or notice. This communication will outline the specific items being audited and provide instructions on proceeding. (We’ve covered the types of notices you may receive and what they mean previously on this blog.)
Responding promptly and following instructions is essential to avoid penalties or further complications.
The audit itself can occur in different ways, depending on the complexity and scope of the examination.
There are three main types of processes:
- The correspondence, or mail audit, which is by far the most common type, is conducted by letters and phone calls and is limited in scope;
- the office audit, conducted at a local IRS office, to verify specific aspects of your return;
- the field audit, which is the most comprehensive and least common type, that requires face-to-face meetings with an auditor.
During the audit, your examiner will ask questions, review documentation, and potentially request further supporting evidence.
After completing the process, the IRS will present its findings and conclusions. This may result in one of three outcomes:
- No changes to your tax return,
- A proposed adjustment to your tax liability,
- A request for additional information or documentation
If adjustments are proposed, you can provide additional explanations or evidence to support your position.
Preparing for an IRS audit: Checklist
You can do two crucial things immediately upon receiving your audit notice.
- Take the audit seriously. Even if you’re sure you’ve done nothing wrong, do not take an IRS audit lightly. Pay attention to deadlines, and organize your documentation by year and the type of income or deduction. Managing your part of the process is your responsibility; the examiner will not do it for you.
- Get representation. Hire a tax professional immediately (contact us here). Failing to do so can be a dangerous mistake. Given the tax code’s complexity, going it alone makes you a sitting duck.
Here are some more actions you take to prepare:
- Review the audit notification. Carefully read through the IRS letter or notice to understand the specific items being audited and the timeframe for response. Take note of any deadlines or requested actions.
- Gather documentation. This includes income statements, expense receipts, bank statements, invoices, and other financial documents. Ensure you have documentation for each entry on your tax return subject to the audit. (For information on the types of records the IRS might request, click here.)
- Organize your records. Use labeled folders or digital folders to keep everything organized and easily accessible. This will help streamline the audit process and make it easier to locate specific documents when needed. (As we have previously written on this blog, smart record-keeping is always a good idea whether you’re being audited or not.)
- Understand the tax laws. This will enable you to understand the basis for your tax positions better and ensure compliance with the applicable rules.
- Review your tax return. Ensure you understand each entry and have supporting documentation for all reported income, deductions, credits, and exemptions. Identify any potential discrepancies or areas that might raise questions during the audit.
- Consider voluntary disclosure. If you discover errors or omissions in your tax return before the audit, this proactive step can demonstrate your willingness to correct mistakes and potentially result in more favorable treatment.
- Be aware of your rights. The IRS has guidelines to protect your rights, including the right to representation, privacy, and to appeal an IRS decision. Understanding these rights will help you navigate the audit process with confidence.
- Seek clarification if needed. It’s better to ensure that you provide accurate and complete information rather than making assumptions that could lead to misunderstandings.
What is an IRS audit looking for?
The IRS’ primary objective is to ensure the accuracy and completeness of your tax return.
Towards that end, your examiner will closely examine various aspects of your financial records to verify that you have reported your income correctly and have claimed legitimate deductions, credits, and exemptions.
Here are some key areas that an IRS audit typically focuses on:
- Income accuracy
- Deductions and credits
- Business expenses
- Self-employment income
- Tax withholding and payments
- Filing status and dependents
- Unreported income
Of course, the specific focus areas of an IRS audit can vary depending on the nature of your tax return and the information that raises concerns or triggers the audit.
What should you not say in an IRS audit?
First, and most importantly, do not lie to the auditor under any circumstances—that is a federal crime.
In general, be upfront, prompt, courteous, and professional. Do not joke around with an IRS employee. During the examination, answer only the questions they ask and do not say anything they might interpret as a threat.
Avoid making speculative statements or guesses about any unclear or uncertain information. Stick to the facts and provide accurate details based on your available documentation and records.
Only bring up personal or unrelated information that is relevant to the audit. Stay focused on providing the necessary information and addressing the specific questions asked.
Finally, refrain from giving incomplete or partial answers that may raise further suspicion or require additional follow-up questions.
Ultimately, the keys to successfully preparing for an IRS audit are knowledge, organization, a cooperative mindset…and, once again, expert guidance from tax professionals (like us).
Would you like some help?
If you are a client and would like to book a consultation, call us at +1 (212) 382-3939 or contact us here to set up a time.
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