In a previous blog we looked at why you may be audited by the IRS. Now we will look at what happens should this take place. Though the very idea of being audited by the IRS can make most people worry, in most cases it won’t result in an adversarial face to face interview – in 75% of cases, an IRS audit will be by letter and will go no further.
Let’s go through the three kinds of IRS audit and see what it entails.
As we indicated above, 3/4ths of all IRS audits are by mail. They will ask you some questions about your current (and sometimes previous) tax filings and you will reply by mail with the evidence they request. According to the IRS website, “If we conduct your audit by mail, our letter will request additional information about certain items shown on the tax return such as income, expenses, and itemized deductions.”
Often enough they will request you modify your tax filing to account for some minor errors you made and a payment will be made – either you to them or from them to you. Yes, the IRS pays out around $1 billion a year in mistakenly taken taxes so this could end up putting a smile on your face and not a grimace!
There are different reasons that you might have a face to face interview. The IRS website again: “If you have too many books or records to mail, you can request a face-to-face audit.” In this case you will choose to meet them in the belief that over a few hours you can get them off your back.
They may call you in to the local IRS office though. You have the right to bring a lawyer or an accountant with you to the meeting, though this is not always necessary. Someone bringing lawyers to a meeting can heighten the tension and may even suggest you have something to hide when you really haven’t. An accountant who knows their way around your finances can speak in the IRS agent’s language and can perhaps more rapidly clarify the situation with the agent.
If you are invited to meet the IRS agent at their office, bring all pertinent information to their inquiry that they will have set out in their letter explaining why they wish to audit you. This could mean three years worth of bank statements or receipts for a certain kind of expenses. For example, perhaps you travelled rather more often than normal for your work one year so you will need all your flight and hotel tickets as well as concrete explanations for those business trips.
Field visits are when things are quite serious indeed. They are far more expensive to organise than a mail audit and you must remember that the IRS is all about profits – they will not do something expensive like a field visit unless they have reasonable cause to believe that a visit to you is absolutely necessary. These visits will take place when there are a number of red flags on your tax filings suggest deliberate under-reporting of your true tax burden.
For a field visit to take place you may be doing a combination of things that suggest deliberate under-reporting of your income. You may be living a lifestyle that should not be possible on your declared income, have declared unusually high expenses for a certain type of deduction, or may have not reported an income stream such as an investment. There are literally dozens of other major red flags that can make the IRS believe you are deliberately evading tax, and if serious then you may get visited for this.
As a general rule most people are into minimising their tax burden and not into evasion. The IRS recognises this. Should your business plan be going very well and income sees double or even triple digit growth your should think of hiring an accountant or tax advisor and stop self-filing your tax return. For the most part an accountant or tax advisor will save you more in taxes than you pay them in fees, but should the IRS audit you you are in a safe place from the outset – a reasonably simple explanation face to face or by mail can get the Revenue off your back! If you do self-report and make mistakes, and are audited because you have made errors due to your lack of understanding of the tax system then an audit could end up adversarial when an accountant could have prevented it in the first place.
There are cases where improper record keeping can result in a higher post-audit tax demand than necessary. According to 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.” That means you need to keep records of all your expenses for six years in case of an audit. There are cases where a legitimate expense has been made but the person claiming it no longer keeps the record of that expense. If you don’t have the record and the IRS auditor spots it they may demand you adjust your tax filing without that tax deduction included.
It’s not the end of the world!
As we indicated at the outset of this article, an IRS audit isn’t the end of the world. Most issues are accidental under-reporting of the final amount of tax owed and though you may imagine an adversarial cross examination in a spotlit office by a growling accountant, it really isn’t the case in reality! From the outset of filing your tax return, bear it in mind that you could be audited and have evidence for every expense made. If you keep those expenses for six years then you really have nothing to worry about.