How Tax Audits Work

Many individuals who are in the process of preparing their tax returns or have completed filing them often wonder about the possibility of being subject to an IRS tax audits. Despite common misconceptions, the likelihood of undergoing tax audits by the IRS is frequently overstated.

It is crucial to ensure accuracy and completeness when filing your tax return, as this plays a significant role in the overall process. Despite this emphasis on precision, the chances of being chosen for an audit are generally slim. Surprisingly, fewer than 1% of taxpayers go through an audit in a single calendar year.

In the year 2023, a mere 23% of tax audits led to taxpayers facing the IRS in person, with the majority being resolved through written communication. This information serves as a useful reference for navigating tax audits if you should ever encounter one.

What is an IRS audit?

Conducting an IRS audit involves a thorough assessment and analysis of financial data and records to validate the accuracy of reported tax information. Throughout the audit process, the IRS meticulously reviews the reported amounts to confirm their correctness and identifies any inconsistencies that require resolution.

When undergoing an audit, the IRS may ask for various records to be provided, such as income documentation, expense records, evidence of deductions and tax credits, financial and investment records, and additional miscellaneous documents that validate the information reported on your tax return.

The Types of Tax Audits

Are you exploring various audit methods? Typically, correspondence audits necessitate submitting specific information or evidence regarding items listed on your tax return. On the other hand, office audits involve meeting in person at an IRS office to delve deeper into specific aspects of your tax filing.

When conducting field audits, they are usually carried out at the location where you reside or operate your business. This specific type of audit is known for its thoroughness and depth, making it ideal for investigating intricate matters or instances where the IRS must review a large volume of documentation.

Before undertaking any dealings with the IRS, it is imperative to ascertain the specific documents required in advance. It is advisable to refrain from volunteering surplus information to the IRS official, as this might prompt further queries from the agency.

When your paperwork aligns with the initial filing, encountering issues during the audit process is unlikely, and the outcome will likely indicate “no change.” Should the auditor uncover any inconsistencies (and you concur), you are required to endorse the documents and settle any outstanding tax obligations. Conversely, if you dispute the findings presented by the auditor, you retain the right to challenge the verdict through an appeals process.

Are Tax Audits Common?

Despite a slight uptick in audits in recent years, the probability of undergoing an audit remains minimal. Out of all individual tax returns submitted between Tax Years 2013 and 2021, the IRS scrutinized only 0.44% of returns processed by the conclusion of the fiscal year 2023.

According to the latest information in the 2023 IRS Data Book, a significant majority of audits were carried out through mail correspondence. In the same year, 77.3% of audits were completed via correspondence, while 22.7% were conducted in person. The IRS findings indicate that utilizing mail correspondence for audits is not only cost-effective for the agency but also alleviates the burden on taxpayers.

Should the information you provided in your tax return not align with what was reported to the IRS, there may be a discrepancy that requires clarification. Simply offering supplementary details or an explanation could resolve any inconsistencies and meet the IRS’s criteria.

It is crucial to avoid jumping to conclusions and assuming the IRS is always right. It is essential to thoroughly investigate any discrepancies and have the correct information ready to provide a response to the IRS if needed.

What Triggers an IRS Tax Audit

Should the IRS suspect inaccuracies in your tax return, an audit may be initiated. Understanding the common factors that can trigger an IRS audit is essential for taking proactive steps to mitigate such risks going forward.

Claiming Large Losses.

Should you declare an abnormally high business loss or a loss that exceeds your reported income by a significant margin, you may draw the attention of auditors. Furthermore, any losses claimed must be substantiated by genuine business endeavors. It is imperative that the IRS confirms your aim to generate profit and confirms that your business operations are not merely a hobby. When individuals file for large rental loss deductions that deviate significantly from industry standards, it may catch the attention of the IRS.

Claiming Large Tax Deductions.

When taxpayers make deductions that deviate from the norm or exceed expectations, they significantly increase the likelihood of being selected for an audit. Tax audits usually occur when taxpayers try to claim personal expenses as business-related, such as using home telephone bills or exaggerating the size of their home office space by including unnecessary areas like the living room or bedroom.

Should taxpayers opt for substantial deductions from exorbitant medical expenses or a plethora of miscellaneous deductions, they may find themselves drawing audit scrutiny. Likewise, ostentatious business deductions about lavish meals or extravagant travel expenses are more likely to attract audit attention.

Claiming Large Charitable Contributions.

Should you seek to deduct a substantial amount for charitable contributions, particularly non-cash donations, there is an increased likelihood of undergoing an audit. The criteria for documenting charitable gifts have become more rigorous compared to the past.

Running Cash Businesses.

In light of the potential for concealing income within businesses that handle frequent cash transactions, such as salons, deli, laundromats, etc. the IRS has taken steps to combat this issue. Recently, the IRS introduced a comprehensive guide for its agents specifically addressing cash-intensive businesses. Ensuring thorough documentation and accurate reporting is essential to navigate this potential scrutiny effectively.

Crypto Transactions or Foreign Bank Accounts.

Lately, the IRS has shifted its attention towards individuals involved in cryptocurrency transactions, aiming to verify the accuracy of reporting and deter any instances of underreporting. Furthermore, taxpayers who neglect to disclose their foreign bank accounts or earnings derived from foreign sources may also face scrutiny that could result in audits.

How Do I Know If There Is a Tax Audit?

When an audit is initiated by the IRS, they will always communicate the information through mail rather than over the phone. It can be a daunting experience to receive an audit notice from the IRS, but rest assured, you have the opportunity to collaborate with them to verify the accuracy of your tax return. Here are the steps you should take upon receiving an IRS audit notice.

Upon receiving correspondence from the IRS indicating an audit, additional documents may be requested to support your tax return. In such instances, it is important to promptly furnish the requested documentation within the given timeframe, usually within 30 days.

Whenever your documentation is submitted, the IRS relies on these records to verify the accuracy of your tax return. Should you find yourself in the challenging situation of receiving an tax audit notice from the IRS, it’s important not to panic. Instead, approach the situation calmly and remember that you have the opportunity to collaborate with the IRS to substantiate the information on your tax return. Here are steps you can take when faced with an IRS audit.

This entry was posted on Thursday, August 15th, 2024 at 8:00 am and is filed under Tax Tips and Tricks. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.