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What is an IRS Tax Audit?
An IRS Tax Audit is an examination of what you claimed on your yearly tax return to verify that information such as your income and claimed deductions are accurate.
The Internal Revenue Service (IRS) will select to audit your return if something seems out of the ordinary.
There are 3 main types of IRS Tax Audits:
- Mail Audits: You’ll receive a mailed letter as notice that your return is being audited. This is the simplest IRS tax audit and does not require you to meet with the IRS auditor in person. For mail audits, the IRS is simply requesting additional information to support what you have claimed on your tax return.
- Office Audits: A more in-depth audit, office audits involve a local auditor who will conduct an in-person audit. This will include them questioning information noted on your return. When these meetings take place, you have the right to request an attorney to help represent your case and ensure you get the best outcome.
- Field Audit: The broadest type of examination that the IRS will conduct, a field requires an IRS auditor to conduct an audit at your home or business. These audits will take place if there’s more than one red flag found on your tax return, usually in the deductions section.
Why am I being selected for an audit?
When a person is selected for an audit, it does not always suggest that there is a problem on your tax return. The IRS selects returns for audit for two main reasons:
- Random selection and computer screening: Some tax returns are selected at random when compared to a ‘norm.’
- Related Examination: The IRS may select your tax return to be audited if your returns have suspicious transactions that are like other taxpayers. Such as, business partners or investors, who were selected for an audit.
How am I notified?
The IRS will notify you by mail if your tax return has been selected for an audit. The IRS will not call about an audit by telephone.
What do I need to provide?
The IRS will provide you with a list of items that they need for your audit. Some items that you will need to provide include receipts, legal papers and more.
The IRS only accepts some electronic records created by tax software.
How far back can the IRS go to audit my return?
The IRS will go back a minimum of three years for an audit. If they notice a major, recurring issue on your tax returns, they may audit up to six years. The IRS can only audit returns for the past six years, so always keep your tax return documentation for a minimum of six years.
How long will my audit take?
The time frame for all audits is different and depends on the complexity of the situation. It can also depend on how long the information being requested takes to produce, as well as the availability of both parties for scheduling meetings. Most of all, it can take time depending on your agreement or disagreement with the items discussed in the audit.
How long does a IRS audit take?
An IRS audit can take up to three months to complete, from beginning to end. This includes the following steps:
- Four weeks for planning
- Four weeks for fieldwork
- Four weeks for compiling the audit report
What are my rights?
The following article on “Publication 1, Your Rights as a Taxpayer” explains all your rights when it comes to the examination, appeal, collection and refund process. The Rights include:
- Professional and courteous treatment by the IRS.
- Privacy and confidentiality about all 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 be represented by yourself, or an authorized representative, like an IRS tax attorney.
- A right to appeal disagreements, both within the IRS and before the courts.
How does the IRS conclude an audit?
A IRS audit can be concluded in 3 different ways:
- No Change: The result of all items provided resulted in no change to your tax return.
- Agreed: The IRS performed changes and you understand and accept all changes to the tax return.
- Disagreed: The IRS proposed changes that you disagree with.
The Tax Audit Process: Procedure, Rules & Guidelines for IRS to Audit
IRS tax audits can be completed by two different government departments, including the IRS and your State Department of Taxation. Below are some guidelines, rules and procedures to help with the IRS tax audit preparation and what could happen after an audit.
How Tax Returns Are Selected for an Audit
As discussed above, the IRS selects a person for an IRS audit for two basic reasons, however there is a more complex system of selection, which we will discuss below. The IRS has a computer database that performs an analysis on every tax return. There are different computer systems that perform various types of analyses and statistical analyses to score your tax return based on its likelihood of being correct.
The IRS also performs human analysis on tax returns, as described below:
- The Discriminant Function System (DIF): The first IRS computer system gives your tax returns a score that determines the accuracy of the tax return. The higher the score, the higher the chance that your tax return will be selected for audit.
- The Unreported Income Discriminant Function (UIDIF): The second IRS computer system looks at different factors than the DIF system. This system checks if the proper income was reported on the tax return. The system gives a score based on expense and income. The main item that would raise a red flag is if the return’s expenses exceeded the income. This suggests there was income not reported on the tax return.
- The Information Returns Processing System (IRP): This computer system stores information from third parties that are required to report taxpayer income. This includes employers, banks, brokerage firms, social security and other institutes. This system checks if returns included all information provided by third parties.
- Incriminating Documents Turned Over to IRS: This system provides information that can point out individual tax returns that are involved with the promoter’s tax avoidance schemes.
- Audits of Related Entities: If the IRS audited a tax return that is associated with another taxpayer, any associated taxpayers’ returns may also be audited. This includes business partners, for example.
What Happens After an Audit
- Approve of Audit Findings: If you approve with the audit’s findings you would then return a copy of the report with IRS Form 870: consent to Proposed Tax Adjustment. Once this IRS form is signed, you are agreeing that you have a tax deficiency. If you owe taxes you can create a payment plan with the IRS. The payment plan will be determined by how much money you make and how much you owe.
- Disapprove of Audit Findings: If you disagree with your audit’s findings, you will have 30 days to do the following:
- Mail in additional documents that you want the IRS to consider
- Request a meeting with the examiner
- Discuss your audit with the group or senior managers
- Request an Appeal: If your proposed changes were disapproved, you can request an appeal.
What happens when you agree with the audit findings?
If you agree with the audit’s findings, you will have to sign the examination report (or a similar form depending upon the type of audit).
If you owe money, there are payment options available. See Publication 594, The IRS Collection Process, for payment options.
What happens when you disagree with the audit findings?
When you disagree with the audit findings you can request a meeting with an IRS manager. The IRS also offers mediation or, if you have enough time remaining on the statute of limitations, you can file an appeal.
What are IRS Tax Audit Penalties?
Did you receive a notice for a IRS tax audit? Contact Sheppard Law Offices to get the best result possible. Below is a list of the different penalties that you could be facing if you don’t hire a skilled IRS tax attorney.
Accuracy Related Tax Penalties
If the IRS finds you purposely lied about a large amount on your tax return, you could be facing penalties for 20% of the amount that was underpaid on your taxes. In big cases, you could be see a penalty that is double: 40% of your total underpaid taxes.
The following is a list of the different types of accuracy-related penalties that could result in a IRS tax audit.
- Negligence or Disregard of Regulations: Failure to reach tax code rules, such as not filing your taxes.
- Disregarding IRS Rules or Regulations: Tax returns that are inconsistent with the IRS regulations.
- Substantially Understating Your Taxes: Filing your income by 10% (or $5,000, whichever is greater) less than what it should be.
- Substantially Misstating the Value of Property: Overstating amount given for donations or undervaluing depreciating property. Undervaluing by 200% results in a 20% penalty, by 400% results in a 40% penalty.
- Substantially Overstating Pension Liabilities: Overstating amount for pension liabilities by 200% results in a 20% penalty, by 400% results in a 40% penalty.
- Substantially Understating a Gift or Estate: Claiming the value of gift property’s tax or estate tax return at 65% or less than its actual market value results in a 20% penalty, while by 40% less results in a 40% penalty.
- Understatements Related to Reportable Transactions: Underclaiming tax liabilities due to a tax shelter or tax avoidance transaction results in a 20% penalty.
Penalties for Failure to File Returns and Pay Taxes
If you are late filing your taxes or paying the amount owed, there will be a 5% penalty towards the unpaid taxes, charged to you each month (up to a maximum of 25%).
If your taxes are 60+ days late, there will be a minimum penalty of $135. It’s important to remember that filing your taxes on time but paying late holds less of a penalty than not filing your taxes at all.
If you don’t pay your taxes owed after an audit, the IRS will give you a penalty of 0.5% each month of nonpayment. The penalty period starts 21 days after the IRS issues the notice of payment. If an audit results in accuracy-related penalties, fraudulent failure to file a tax return or civil fraud, the IRS adds an annual interest of 3%.
Civil Fraud Penalty
When it comes to civil fraud, fortunately consequences don’t include jail time. If you’re found to have committed civil fraud, the IRS may issue a large penalty of 75% on any tax that resulted in fraudulent activity.
Fraudulent Failure to File a Tax Return
Deliberate failure to file your tax return can be a civil offense or misdemeanor criminal offense. If criminal charges are filed, you may be sentenced to jail time for one year, plus $25,000 in fines for each year that you fail to file your taxes.
The statute of limitations for criminal charges is six years, however there is no statute of limitations for civil charges.
Willful Failure to Pay Estimated Taxes or Keep Records
If the IRS charges you with a criminal offence for failing to pay your estimated taxes, it can result in an audit or criminal investigation and you could face jail time of up to a year and $25,000 in fines for each year you are charged.
Filing a Fraudulent Return
If you are found filing a fraudulent IRS tax return, the result may be an IRS audit or investigation. As the result of an IRS investigation, you could face up to three years in prison and up to $100,000 in fines.
Tax evasion is the willful act of concealing your finances and assets to avoid paying taxes. If an IRS audit or criminal investigation results in a tax evasion conviction, you could face up to five years in prison and up to $100,000 in fines.
If you disagree with an audit result, you can apply for an audit reconsideration by:
- Appealing a statement, explaining your reasons for requesting an audit reconsideration
- Fill out Form 1099, cancelled checks, bank statements and similar new documentation
- Providing copies of previously supplied materials
- Providing copies of correspondence from the IRS
Offer in Compromise and Penalty Abatement
If your request for audit reconsideration is denied, you may request an Offer in Compromise (OIC), which settles your tax obligation for a fraction of what you owe.
When applying for a OIC, the IRS usually approves requests for penalty abatement based on how reasonable they determine the cause is. To request a penalty abatement, file IRS Form 843: Claim for Refunds and Request for Abatement, along with copies of any documentation you may have to support your request.
What happens when you agree with the audit reconsideration
If you find that all the items are in place for the audit, and agree with all findings, you will be asked to sign the examination report.
If you owe money in the end, there are several payment options available with the IRS. Publication 594, The IRS Collection Process, explains the collection process in detail.
What happens when you disagree with the audit reconsideration findings?
If you disagree with the findings during the audit, you can request a conference with an IRS manager, or follow best practice and contact a trusted IRS audit attorney to help your case.