I Got Audited by the IRS
Nothing is more stressful than a Notice of Audit from the IRS or State for income, sales or employment taxes. Simply put, it means your records are going to be examined and any potential mistakes (both good and bad) could possibly come to light. The point of an audit is to verify your records are correct; this is a key point! We have represented many clients in audit where the end result was the IRS owed our client money. While a refund is not always the case, we find many clients underreport expenses or miss credits. While an audit is clearly not something you wish for, with the proper representation, it MAY not need to be feared. That being said, if you take the right steps you can get past this part of your tax life in no time at all.
What is a Tax Audit?
A tax audit is an accounting procedure where the IRS examines your individual or business financial records to ensure you filed your tax return accurately. If you prove that your initial return was complete and correct, you won’t be asked anything further. However, if the IRS finds errors or a purposeful misreporting, you’ll have to pay the recalculated return amount and any interest and/or penalties.
Tax Audit by Mail or Correspondence Audit
A correspondence audit, or an audit received by mail, is an audit that is conducted through correspondence. In a correspondence audit the IRS sends you a notice directing you to provide information and support for one or several items on the return. In these notices, there will be a due date provided and it’s of the utmost importance you do not miss these deadlines.
Tax Audit in Person
There are three different types of in person audits.
1. Office Audit: the IRS Service Center asks you to bring certain documents in to your local IRS office. The audit is conducted there.
2. Field Audit: an IRS agent comes to your home or place of business to conduct the audit in person.
3. Taxpayer Compliance Measurement Program Audit: (TCMP) this is the most extensive type of audit, where every part of your tax return must be substantiated by documents, including birth and marriage certificates. The primary purpose of this audit is to update the data used to write the computer scoring program.
Call us at 800-829-7483
If I am Audited, Does It Mean I Am in Trouble?
Your taxes may be audited for a variety of reasons, including:
- Specific activity on your return, such as cash wages, 1099 and W-2 forms that don’t match your reporting, high deductions relative to your income, reports inconsistent with previous years, etc.
- Related examinations, where your report involves transactions with someone else being audited
- Automatic flags, where computer programs find outlying “scores” on returns (ex: above average withholding)
- Random selection
All IRS Notices or Letters contain a notice number in the upper right-hand corner. These numbers will further inform you about the specific issue(s) with your tax return. Once you know what you are being audited for, you can narrow your focus and start gathering relevant documents.
How Far Back Could the IRS Audit Me?
As best stated on the IRS website: “Generally, the IRS can include returns filed within the last three years in an audit. If we identify a substantial error, we may add additional years. We usually don’t go back more than the last six years.
The IRS tries to audit tax returns as soon as possible after they are filed. Accordingly most audits will be of returns filed within the last two years.
If an audit is not resolved, we may request extending the statute of limitations for assessment tax. The statute of limitations limits the time allowed to assess additional tax. It is generally three years after a return is due or was filed, whichever is later. There is also a statute of limitations for making refunds. Extending the statute gives you more time to provide further documentation to support your position; request an appeal if you do not agree with the audit results; or to claim a tax refund or credit. It also gives the IRS time to complete the audit and provides time to process the audit results.
You don’t have to agree to extend the statute of limitations date. However if you don’t agree, the auditor will be forced to make a determination based upon the information provided.”
I Don’t Have Receipts; Now What?
If you find there are receipts missing, or you don’t have copies, don’t panic! There are other ways to prove your expenses other than receipts…unless you paid in cash, then that may be a bit more difficult.
What Documents Could I Use to Prove My Income and/or Expenses?
Whatever the reason your receipts are not available, there are other ways to prove your income and/or expenses. Here are just a few examples:
- Bills
- Canceled checks
- Legal papers
- Loan agreements
- Logs or diaries showing dates and locations of travel (suggest handwritten with a different pen each day)
- Tickets
- Medical and Dental records
As a reminder, never send the IRS original records, only send them copies as they will not return the originals. In addition, what if your documents do not arrive if you sent them by mail? Your originals are now gone, and you really have nothing to present.
Call us at 800-829-7483
What Happens at the Conclusion of the Audit?
An audit can end in three ways: No change, agreed or disagreed.
If you agree with the findings, this doesn’t mean you are guilty, it merely means there was a calculation error. We are all human and sometimes these things happen. They key is to learn from this mistake.
If you agree with the audit outcome, you will be asked to sign the Audit Report. If you end up owing, you will need to make a payment in full or work out another plan with the IRS.
If you disagree with the audit outcome, you will need to request a conference with the manager of the IRS Auditor. If you still disagree after speaking with the manager, you will be offered a mediation or to file an Appeal. These options will be allowed if there is enough time remaining on the Statute of Limitations, meaning the time the IRS has to Audit.
How to Avoid an IRS Tax Audit?
Here are eight ways to avoid an IRS Tax Audit
1: Failing to Report All Taxable Income
This is one of the top audit triggers, failure to report all income.
Solution: If you do not know what should be on your return, get a copy of your IRS Wage & Income transcript. This will help you identify potentially missed items of income.
2: Taking Higher-than-Average Deductions
Taking EVERY deduction is each taxpayers right; however, deductions that are in excess of the norm could get you audited. Especially if they are high in relationship to your income. For example, if you made $47,000 in 2014 and contributed $23,500 to several charitable organizations, you would want to keep very detailed records because you have a high probability of being audited.
Solution: You would want to keep very detailed records because you have a high probability of being audited.
3: Business Losses for Self-Employed or Sole Proprietor Taxpayers
Business losses in the initial couple years of a business are common. If you are still claiming losses in your third year or later, you have significantly increased your chance of being audited.
Solution: In the initial year of the business, develop a business plan that details the projections of the business, in particular, in which year it is projected to be profitable. Include your basis for these projections, especially if the projections are based on a similar businesses or your own prior business. Continually revise your projects based on the progress of your business. This will help to document your profit motive, even if your business losses should exceed the first three years.
4: Be careful with those Self-Employment Deductions
Being in business for yourself provides some significant opportunities for deductions. The IRS knows a fair amount of self-employed individuals may be taking deductions that are not related to their business or are exaggerated.
Solution: Keep excellent records and avoid mixing personal expenses and business deductions. At some point in your business life cycle you may want to look at other business structures.
5: Business Use of Home Deduction
While the business use of home is not the audit red flag it used to be, you certainly want to understand the requirement and make sure you have great substantiations for the deductions.
Solution: Your home office must be exclusively used. Read IRS Publication 587 to ensure you qualify for the home office deduction, according to the IRS.
6: Comparison to others in your industry or profession
The IRS does a pretty good job of keeping statistical information of income based upon industry and profession. If you are significantly outside the norm, you have increased your chance of being audited.
Solution: Have an understanding of how your income compares to that of your industry or profession. If it differs significantly, you should be prepared to answer why yours is either higher or lower than others in your industry or profession.
7: Your income is $200k or higher
It is a fact of life, the more money you make the more likely you are going to being audited by the IRS. The IRS knows people make more mistakes as the volume of their returns increases. The IRS also knows they get a higher payoff when auditing these types of returns.
Solution: Ensure that you report all income and have the substantiation for your deductions. As your income increases, it makes sense to upgrade the experience of your tax professional.
8: If you are in an industry or profession were people get paid in cash
Anytime you are in an industry or profession that gets paid in cash, you are more likely to be audited. In these types of audits, the IRS tends to also look at the lifestyle of the audited. They are verifying that the lifestyle matches the income that is being reported.
Solution: Make sure you are reporting ALL of your income. In an audit the IRS agents tend to ask specific questions that will tell them when someone is hiding their true cash income.
Call us at 800-829-7483
How Can I Keep Organized Records of My Income and Deductions?
Now that you have been through the IRS Audit process, the time to start organizing your receipts and documents is now.
- Use folders to file your receipts and documents. Label them as Medical/Dental, loan agreements, etc. Use separate folders for each expense to make them easier to file. Lastly, file them in order by month; January in front and December in the back.
- Scan these same receipts and documents into your computer and file them the same way you did by paper. This is a good back-up in the event you move, lose them to a fire or flood, etc.
- When you make your mileage log or journal, we suggest using a different pen for each day of your log. This is a good preventative measure as it won’t look like you completed the log in all the same day. Be sure to log daily, though, even if it’s at the end of the day. In addition, there are a lot of good apps out there that will log your mileage and show the locations you went day by day.
Finally, don’t use cash to pay for expenses. It’s much harder to prove a transaction occurred, especially if it’s with another person and not an established business. In our firm, we advise clients any amount over $50 a receipt should be requested.
Should I Seek Help with an IRS Tax Audit?
It is typically not advisable to represent yourself in a tax audit case. An experienced professional, such as a Certified Tax Resolution Specialist, Enrolled Agent, Attorney or CPA, will have extensive tax code knowledge and can act as your representative before the IRS. If you have one of these representatives, unless summoned to appear (not likely), you will not have to meet with the Revenue Agent. This is a very good thing because taxpayers tend to answer questions without really understanding what is being asked, OR Revenue Agents ask trick questions that are designed to lead unsuspecting taxpayer down a primrose path. Think long and hard before deciding to represent yourself in an audit.
Call us at 800-829-7483