Why am I being Audited by the IRS?
When you receive a notice from the IRS that they have selected one of your income tax returns for an audit, the first thing to remember is that just because the IRS has selected your return does not mean that you have done something wrong or that there is necessarily anything wrong with your tax return.
The IRS audits only approximately one percent of tax returns filed each year. Many of these tax returns are two or three years old, as it takes time for the IRS to process all of the returns it receives and make a decision about which ones to audit.
The IRS uses two primary methods for selecting the tax returns it audits
First, there are certain factors that the IRS looks for on a tax return that can lead the IRS to select a given tax return for an audit. The IRS keeps the exact list of those factors and the formulas it uses to evaluate them a secret. However, based on returns historically selected for audit, it is clear that the factors that can trigger an IRS audit can include but may not be limited to the following:
- Reporting business expenses that exceed income year over year, resulting in no profit in that business for multiple years
- Receiving significant income from self-employment or rents, where there is the opportunity for an individual to underreport that income since the income is not reported to the IRS by a third party
- Claiming an unusually high number of deductions or unusually large deductions given the level of income on the return
- Underreporting income as compared to the amount of income reported to the IRS by a third party, such as wages reported to the IRS by an employer or interest or other investment income reported to the IRS by a financial institution
- Having a tax return that is somehow related to other tax returns the IRS has found to be using questionable tax reporting practices
In addition, the IRS has audit projects at times that focus on certain individuals or groups of individuals. These audit projects occur when the IRS has reason to believe that a certain group has a much higher rate of filing fraudulent tax returns than does the average member of the population. Therefore, it makes sense from the IRS’ perspective to focus more of their audits on that group, in an effort to recoup tax dollars that are otherwise being underpaid.
Second, the IRS selects a few tax returns for audit at random. While the number of returns audited on a random basis varies year to year, in general the random selection appears to be a very small portion of the total returns audited by the IRS. This is because the IRS has sufficient populations of returns to audit already where they believe there is a higher likelihood of finding fraudulent activity that will give them higher tax revenue, so the IRS does not have resources to spend auditing many returns at random.
When the IRS audits tax returns of individuals at random, those returns can be ones at various income levels.
What should I do if I receive a notice that the IRS wants to audit my federal income tax return?
There are several steps taxpayers can take to prepare for a tax audit, the most important of which may be a step taken before they file their tax returns. However, there are likewise important steps a taxpayer can take to get through an audit in the event the IRS selects their tax return for an audit.
Ensure you have support for claimed deductions before filing
The IRS provides plenty of opportunities for taxpayers to claim legal deductions on their tax returns. Just as it is the responsibility of taxpayers to be aware of deductions available to them and to enter those deductions on their return, it is also the responsibility of taxpayers to ensure they have evidence to support the deductions they claim.
Taxpayers should ensure that before they claim a legally allowed deduction that they have whatever paperwork or other evidence that supports the deduction and its accurate. In addition, taxpayers should ensure they maintain that evidence for at least three years after filing a given tax return.
By ensuring the claimed deductions are valid and support by evidence maintained by the taxpayer, taxpayers can make sure they are prepared in the event the IRS selects their return for an audit. Of course, once taxpayers receive notification from the IRS that they are being audited, it is too late to perform this step. However, it is something taxpayers can keep in mind as they prepare tax returns going forward.
Review the details of the audit notification from the IRS
The IRS can notify a taxpayer of an audit by sending a letter through the mail or by calling the taxpayer on the phone, in which case the IRS will send a letter afterward to confirm the details of the audit. In either case, the taxpayer should review the audit notification to understand what areas of their tax return are being questioned and whether the audit will be conducted through the mail or in person.
The taxpayer should prepare only whatever information is necessary to address the specific areas of concern identified by the IRS in the letter. If the taxpayer provides information beyond that requested by the IRS, there is a chance it could raise additional questions.
The taxpayer should ensure the information requested by the IRS is made available in a timely manner, either returning it in the mail by the requested due date or bringing it to the meeting with the IRS as scheduled.
Engage a tax attorney or other tax professional help to prepare for the audit
Many tax subjects can be complicated matters. If the taxpayer does not understand the tax law in a given area or the specific nature of the audit request from the IRS, or the taxpayer used a tax attorney or other expert to help prepare the tax return, it is often wise for the taxpayer to engage that individual during the audit.
Hiring a tax attorney to assist with an audit should not be considered a sign that the taxpayer is attempting to hide something from the IRS. Tax attorneys and other such individuals are often experienced in dealing with the IRS concerning tax audits. They can advise the taxpayer on how to prepare for the audit and actually attend any meetings with the IRS along with the taxpayer.
A tax attorney can also speak on behalf of the taxpayer at any IRS meetings, ensuring direct contact between the taxpayer and the IRS agent conducting the audit is minimized (and thus that the chances of the taxpayer misspeaking about a subject are minimized).