Few events inspire more dread than an IRS tax audit. Even if you're confident you've accounted for every cent of income and only taken legitimate deductions, it's hard not to worry what a close examination of your tax returns might uncover -- not to mention the hours of time you'll have to spend tracking down old records and receipts.
Here are a few pointers to help allay your fears and better prepare in case you should ever get chosen for the dreaded IRS audit:
- Correspondence audit, which is conducted entirely by mail. You'll receive a letter from the IRS asking for additional information about specific items on your tax return such as income, expenses or itemized deductions. (This is the most common type of audit.)
- Field audit, where an IRS agent comes to your home or business to examine your records and observe where you work firsthand. Requests to transfer the audit to another location, including an IRS office, will be considered but may not be granted.
- Office audit, where you must be interviewed at an IRS office. Be sure to take documentation that supports items under question so you don't waste the auditor's time.
(Note: The IRS will only contact you by mail or telephone to initiate an audit, never by email. If you receive such a scam email, report it to the IRS.)
According to Chris Kollaja, a certified public accountant and partner at A.L. Nella & Company in San Francisco, California, if you're having a correspondence audit and you feel your records are too voluminous to mail, you can request a face-to-face audit.
"You can also ask a representative, such as your accountant, tax preparer or lawyer, to help you prepare for the audit and even attend it in your place, if allowed," says Kollaja. "An experienced tax professional can tell you what to expect, guide your responses and keep the audit on track should you get tongue-tied or start sharing more than is necessary."
Kollaja notes that the chances of being audited are low -- just over 1 percent of all individual tax returns are audited each year, although the odds increase nearly four-fold if your annual income exceeds $200,000. "Sometimes returns are randomly selected for audit, but more often it's because something jumped out in the computer analysis each return receives," he explains.
- Taxable income listed on your return doesn't match amounts reported on W-2 or 1099 forms, 401(k) plan or IRA distributions, brokerage accounts, etc.
- Taking above-average charitable deductions relative to your income.
- Deducting business meals, travel and entertainment. The IRS uses occupational codes to measure typical deductions by profession, so significantly exceeding the norm might trigger an audit.
- Claiming the home office deduction. (It's perfectly legal if you qualify; just make sure your records are in order.)
- Failure to report foreign bank account assets.
- Concealing cash income or receipts (tips, large gifts, etc.)
- Engaging in excessive cash transactions over $10,000, which frequently are reported to the IRS by banks, casinos, car dealers and other businesses.
- Complex business or investment transactions.
- Your close relationship to another taxpayer being audited.
- Someone reports suspicious activity by you (the IRS offers a Whistleblower Award).
- Respond to the IRS within the stated deadline -- usually 30 days.
- Gather and organize receipts pertinent to the issues they've identified. This could include statements for credit card, bank, retirement or investment accounts, cancelled checks, W-2 and 1099 forms, cost-basis for property and taxable investments, etc.
- If you won't have all requested information ready in time for the audit, contact your auditor to discuss whether it can proceed anyway, or if they'll agree to postpone it.
- Bring or send only documentation requested in the initial notice. If you're meeting for an in-person audit, keep you answers brief and don't voluntarily provide information that could launch a fishing expedition.
- If the examiner questions you on an item not mentioned in the initial notice, you're allowed to ask for additional time to fulfill additional requests.
- Seek representation, especially if you don't understand the process or if it's a field or office audit.
- Never give original receipts to the IRS agent -- they are not responsible for lost paperwork.
- You're allowed to make an audio recording of the audit provided you sent your agent written notice 10 days before the appointment. Video recordings are not allowed.
- It's your prerogative to ask why your return was selected for audit.
- Always be polite. Acting belligerent or evasive can only hurt your cause.
Generally, the IRS can include returns filed within the last three years in an audit. Additional years can be added if a substantial error is identified. In the latter case the IRS generally won't go back further than six years unless they suspect fraud or you failed to file returns, in which case there is no statute of limitations.
- If you receive W-2 or 1099 forms showing incorrect amounts, make sure the issuer files a corrected form with the IRS.
- Always get receipts for charitable donations, business expenses, medical fees or other items you plan to deduct. Review IRS Publication 17 for rules on itemized deductions.
- To claim deductions for business meals, travel and entertainment, keep detailed records documenting the amount, place, people attending, business purpose and nature of the discussion or meeting.
- If you receive electronic statements for credit cards, utilities or other items you plan to deduct, download a PDF file while they're still available on the biller's website -- it might be hard to get copies three years down the road.
- Know your rights as a taxpayer and how the audit process works. For more details, visit this IRS site.
Bottom line: Think positively -- you might even come out of the audit with a tax refund. It happens.
This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.