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Guide to Tax Law
- Introduction to Tax Law
- What is the IRS?
- Filing Your Tax Return
- Rights of Tax Payers
- Tax Free Income
- What is a Tax Credit?
- Tax Implications of Differed Income
- How Tax Deductions Work
- Recucing Your Taxes with Investments
- Tax Benefits for Homeowners
- Shifting Income withing a Household
- Your Status as a Tax Payer
- Small Business Owners and the IRS
- Minimize Taxes on Your Estate
- Tax Fraud and other Crimes
- Taking Your Case to Tax Court
- What if Your Owe the IRS?
- When to Hire a Tax Attorney
IRS Tax Audits are inquiries from the IRS that seeks to understand and verify the information contained in your tax return. Being the subject of a tax audit can be a stressful and nerve wracking experience; however, with the proper preparation and diligence in maintain and gathering records, the process is manageable. While an audit is not necessarily an accusation of any wrongdoing on the part of the taxpayer, the individual being audited does have a burden on demonstrating to the IRS auditors that the information on their tax returns was accurate, that income was properly reported, and that tax credits and deductions were properly and legally taken.
A tax audit can happen at any time, and the IRS is within its rights to go back three years to review or coordinate an income tax audit for a give tax return. If the IRS wants to audit a particular return, they must complete the audit within three years or they will be barred by the IRS statute of limitations (unless it is determined that tax fraud or a considerable under-reporting of income has occurred).
Who is Selected for a Tax Audit?
While there is no concrete formula for the IRS when selecting individuals to be audited, there are some key factors that make an audit more likely to occur. Essentially, the IRS is trying to verify that the information you submitted on your tax return is accurate and true. When people get paid on a salary basis and their employer pays them regularly through company payroll, it is relatively easy to see exactly what that individual is making for the year. In contrast, for individuals who are self-employed, those who receive the majority of their income in gratuities (tips), or those who own a business that receives a lot of cash (i.e. a pizza shop), it is not as easy to verify and report tax fraud on their tax returns. The result is that the IRS pays more attention to these individuals because of the possibility that their returns are not accurate is higher than people who are salaried employees.
The IRS also looks at individuals who are professionals" and own their own business, such as doctors, lawyers, and accountants. The reason for this is that small business owners often run their businesses on their own and are responsible for their own bookkeeping and accounting functions.
Individuals and households who itemize their deductions may also run a greater risk of being audited, especially if the deductions in specific categories (i.e. medical and dental expenses, charity, taxes, etc.) are more significant than average.
Avoid IRS "RED Flags"
Additional "red flags" for the IRS auditors may include tax returns that are:
- missing required schedules
- missing a required AMT form
- signed by a tax preparer who has a history of problems
- showing a reported income of over $150,000 for an individual
Types of Tax Audits
The IRS conducts three different types of audits: correspondence audits, office audits and field audits. If you are audited, the IRS will notify you in writing and indicate which type of audit you are being subjected.
Correspondence Audit
A correspondence audit is the most mild audit and generally occurs as a result of some minor mistakes on your tax returns. Generally, a correspondence audit can be completed by the taxpayer mailing required forms and documentation to the IRS. Once the taxpayer has submitted all of the requested information, the IRS will review the material and close the audit once all issues have been properly addressed.
Office Audit
An office audit typically involves the taxpayer being required to physically bring documentation to a branch IRS office for review by IRS examiners. Examples of IRS office audits include situations where individuals have claimed abnormally high deductions (i.e. medical expenses) and the IRS wants to see the corresponding medical bills to verify that the information is accurate.
Field Audit
In a field audit, an IRS auditor will come to your home or office (depending on the type of audit) and verify that your tax returns were accurate. The main difference between an office audit and a field audit is that field audits happen on the property of the taxpayer, where office audits happen in the IRS branch office. In some cases, individuals may request that the audit be done at the office of their accountant, and the IRS will go to that alternate location to carry out the field audit.
Dealing with a Tax Audit
Know Your Rights During an Audit
No matter what type of audit is being conducted, every taxpayer has certain rights during the process. These rights include (but are not limited to):
- The right to have an IRS representative provide a complete explanation of the audit process and the steps involved in each phase of the audit
- The right to conduct the audit while being represented by an attorney or accountant;
- The right to amend the tax return being audited and, if necessary, claim additional deductions that were not originally included in the filed tax return
- The right to seek an opinion from the IRS outlining the specific issues that may arise during the audit
Before the Audit Begins
Before the audit begins, it is absolutely critical that individuals have all of the necessary documentation available and in order. If a taxpayer needs additional time to complete the preparation process, they should request a postponement from the IRS.
The IRS has a publication on their website that outlines the rights of taxpayers, including their rights during an IRS audit. All taxpayers should read this document, (IRS Publication 1) entitled "Taxpayers Bill of Rights".
Before the audit beings, the taxpayer should have a clearly defined strategy that they have discussed with their attorneys and accountants (if applicable). Going through a list of possible questions and issues will allow the individual to be prepared on the day that the IRS asks the same question.
Pay close attention to the document request list provided by the IRS. Taxpayers should take care to provide only the documents the IRS has a right to have, and provide the representative a complete explanation.
During a Tax Audit
During an IRS audit, taxpayer should always maintain professionalism and decorum with the auditors. In return, taxpayers should expect that the auditors will be professional and courteous in return. That being said, use caution to not be too courteous – no information should be offered by the subject of an audit beyond what is absolutely necessary. If the auditors do not ask a question, the taxpayer should not offer any additional information. Providing extraneous details will not help an audit along; instead, it could actually hamper the process and drag the audit out longer. If you believe the auditor is not treating you fairly, do not hesitate to ask to speak to their supervisor.
Be honest, direct and make sure to respond only to questions asked by the agent. The most important rule to follow during an audit to always, always, always be honest. The worst thing a taxpayer can do is lie to the IRS agents.
Completing and Concluding an Audit
To successfully finish an audit, the taxpayer should make sure that the auditor has been provided with sufficient answers to all of the questions provided in the request list. By showing the auditor that they are committed to resolving any discrepancies, the auditor will likely try equally hard to assist the taxpayer in wrapping up the audit process.
The audit will truly provide finality if all of the documents requested are available and provide the clarification the auditor is looking for. A taxpayer has the best chances of finishing an audit successfully if all of the background document collection has been done prior to the start of the audit.
Audit Problems
Major problems can arise during an audit if the taxpayer fails to have all of their paperwork in order. If the taxpayer fails to produce records that are able to clearly substantiate the information on their tax returns, the IRS agent will end up spending substantially more time and gone much more in-depth than they would have if the information had been readily available at the time of the audit.
To avoid problems during an audit, always make sure that you have the information necessary to address the questions of the auditor. If you are going to need more time, you should make sure to file a request to postpone the audit.
Appealing a Tax Audit Decision
A taxpayer's biggest asset during an audit is the compilation of their records. If a taxpayer was diligent in keeping track of their expenses, they should be equally diligent in keeping track of their audit. A taxpayer should take note every question that auditor asks and should also take note of every answer given. This information may be helpful later in the process and will be critical if the taxpayer ever needs to appeal the findings of the audit
As soon as you get the examination report, you should take time to carefully go through all of the contents and findings. Do not hesitate to call the auditor after your review if you do not understand certain parts of the report, or if you do not agree with certain findings.
Finally, the auditor will have made recommendations and determinations about your overall tax liability. This decision could potentially have major implications, so a taxpayer should always advocate for their position if they do not agree with the findings. Often times, the auditor and taxpayer can discuss options and get to a compromise on the overall tax liability determination.
How to Appeal an Audit
If the taxpayer does not agree with the findings of the auditor, the taxpayer can first appeal the decision informally by contacting the auditor directly or reaching out to the auditor' supervisor. To file a formal tax appeal, the taxpayer must file the necessary paperwork with the IRS Appeals Office.
The IRS Appeals Office is an entity that is independent of the local IRS office that performed the audit. A taxpayer may appeal the findings of the audit by sending a what is called a Protest Letter to the IRS. In order to file the appeal, the Protect Letter must be sent to the IRS Appeals Office within 30 days of the taxpayer receiving the final audit report.
In the event that an appeal is filed and the taxpayer is unable to reach a suitable compromise with the appeals officer, the taxpayer may be able to appeal further to the U.S. Tax Court, the U.S. Court of Federal Claims, or the U.S. District Court in the state where the taxpayer lives.
How to Prepare for an Appeal Hearing
In order to prepare for an Appeal Hearing, a taxpayer should take all of the suggested steps for preparing for the initial audit, in addition to gathering documentation produced during the audit itself.
For purposes of an appeal, is absolutely critical that individuals have all of the necessary documentation available and in order to present to the Appeals Judge. If a taxpayer is appealing certain findings of the audit report, they should prepare backup documentation to substantiate their claims and convince the Court why the finding are erroneous.
The taxpayer should be ready with a list of questions asked by the auditor along with the corresponding answers given. If a taxpayer can show a Judge that, based on the documentation provided the findings of the auditor do not add up, the Judge will have a greater likelihood of ruling in favor of the appealing taxpayer. Hiring an income tax attorney could be very helpful for a successful case. Preparation is key in getting ready for an Appellate Hearing.