Ultimate IRS Audit Defense Guide: How To Protect Yourself From A Tax Audit
Filing your taxes each year can be nerve-wracking.
Did you take all the deductions you qualified for? Did you fill everything out correctly? Were there any math errors or typos?
No one ever wants to be the subject of an IRS audit, but sometimes they do happen even when you’re not suspected of making any errors.
In this guide, you’ll learn what a tax audit is, how to prepare if you’re being audited, and how to avoid being audited in the future. We'll also cover when it makes sense to seek professional tax representation.
What Is A Tax Audit?
A tax audit is when the IRS decides they want to examine your tax return a little more closely to ensure that all income and deductions you reported are accurate.
Being chosen for a tax audit isn’t necessarily a bad thing; it just means you entered something out of the ordinary on your tax return. This could be anything from purposely leaving off a second stream of income to you taking a huge pay cut in one year so your income drops drastically.
There are three main types of tax audits: Mail, Office, and Field.
No matter what type of audit the IRS decides to conduct in your case, your audit process will begin with a letter from the IRS.
A mail audit is the simplest type of audit, as it doesn’t require you to meet with an auditor.
In many cases, the IRS conducts a mail audit simply requesting more documentation.
If, for example, you reported $12,000 in charitable donations in a tax year, the IRS may send you a mail audit request for proof of those donations. Once you send in proof, the IRS has gotten the information it needs and your audit is done.
However, if you cannot provide the documentation or information the IRS requests in its mail audit, you may be subject to one of the other audit types.
If you are subject to an office audit, you will be asked to appear in-person for an interview by an audit officer. This interview will take place at your local IRS office.
You will be asked to bring information and documentation with you, such as the books for your business or receipts and proof of deductions you took. The audit office examines this information and asks you about different portions of your tax return.
With an office audit, you have the right to bring an accountant or an attorney to represent you.
The field audit is the broadest of all audit types.
During a field audit, the audit officer will visit you at your home or place of business, depending on whether you’re being audited for your personal returns or your business returns.
The audit officer examines records and information and conducts an interview with you. This audit is usually time-consuming and very thorough, and typically is used if the IRS is questioning more than just a few deductions on your return.
It is generally recommended that your accountant is present for this audit, or that you are represented by an attorney.
What Is The IRS Looking For In A Tax Audit?
The IRS routinely reviews the tax returns of both individuals and businesses to ensure that all income claims and deductions are correct.
You can be chosen for a tax audit without there being any legitimate questions about your return. A portion of the audits the IRS conducts annually are chosen at random just as a matter of practice.
However, the IRS also singles out returns that are suspected of fraud or other incorrect information for audits.
Some things that could trigger an audit by the IRS include:
You Make A Lot Of Money
If you make more than $1 million per year, you are roughly four times more likely to be audited by the IRS than if you earned between $200,000 and $1 million annually.
You Own Cryptocurrency
While it may not be a “traditional” method of currency, cryptocurrency still has to be reported to the IRS as income. So, if you trade, mine, or otherwise receive cryptocurrency but don’t report it, the IRS may audit you.
You Failed To Report Taxable Income
Don’t forget to report the money you made from that side hustle! Unless it’s specifically noted as exempt, all sources of income over the IRS threshold are reportable.
The IRS receives copies of any W-2s or 1099s in your name, so if they receive a form that you haven’t reported on your tax return, it can be suspect.
You Made An Error
While typos and math errors can be honest mistakes, the IRS still needs to investigate anything that looks amiss in your tax return.
You Are Self-Employed
If you’re self-employed, you may be more likely to be audited by the IRS. Be sure to carefully check all your income and deductions, and keep a clear paper trail for any deductions you do take.
You Have Three Years of Business Losses
Being a business owner is hard, and sometimes that means you post a net loss for your business. However, if you’ve reported three consecutive years of losses, the IRS may challenge whether your business is a business or if it’s a hobby, resulting in an audit.
You Use Round Numbers
You need to be exact when reporting your deductions, and if everything you take ends in two zeros, the IRS may grow suspicious. Using only round numbers can make the IRS think you don’t have records to back up your deductions and make you more likely to get audited.
You Completely Deduct Your Car As A Business Expense
If you own a business vehicle and report that it’s used 100 percent for business use, the IRS can see that as suspect. Certain portions of your use, such as commuting to and from your office, cannot be considered business deductions.
Something Seems Off
Reporting large deductions on a small income, or business expenses that far outpace your earnings, can make the IRS think there’s some fishy math going on, triggering an audit.
How To Prepare For A Tax Audit
During your tax audit, the IRS has the right to inspect any records or books used to prepare your tax return. It also has can require any person or entity to produce records it may have, so your accountant, bookkeeper, employer, or attorney could be required to hand information over to the IRS.
The IRS likely will request specific records and books they want to inspect during your audit, but be prepared with all your information, including:
- Tax returns under audits
- Applicable financial statements
- Check register
- Anything else that will help you put together a full picture of what went on during the year for which you’re being audited
Take some time to familiarize yourself with all these records, especially if you have someone else who typically manages your books or prepares your taxes. This will help you become more prepared to answer any questions the audit officer may have during your audit.
If your taxes were prepared by someone else or you have someone manage your financial books, it’s a good idea to meet with them so you can go over the return to see if there was something that may have triggered the audit or if it was just a randomly selected audit.
Additionally, the IRS examines your entire lifestyle as part of the audit process. This is especially true if you file as self-employed.
That means, if you have deductions or business expenses that were reported and you cannot explain, you may face tighter scrutiny.
How To Present Your Records To The IRS
Thinking of having to turn over all your financial records to the IRS may seem a tall task, especially if you’re a little disorganized in your filing system.
As an individual, you aren’t legally required to keep formal financial records. You can present receipts, a check register, or other financial records.
The same goes for small businesses.
However, if you do have more complete, formal financial records such as ledgers, you are required to turn them over to the IRS.
Do your best to organize these records so that certain categories of expenses are together, making your records easier for the IRS to inspect. This isn’t required, but more a matter of courtesy. A tax professional can help you organize these records based on their knowledge of what the IRS may look for first.
It’s important that you gather all your applicable financial records and bring them to your audit.
Hiding even a small portion of your financial records can lead to stiffer penalties and consequences that you may not otherwise have faced had you been honest with the IRS.
What If The Tax Auditor Finds Things I Cannot Substantiate?
Everything that you’ve reported to the IRS must be able to be backed up by records and proof. That includes all income, deductions, and applicable business expenses.
The records you present to the IRS must be complete and provide everything they ask for, but offering too much information can open you up to further questions and consequences.
It’s important to work closely with a tax professional to prepare the records that you provide to the IRS for your audit.
When preparing for the audit, you may find items for which you don’t have proof, such as a deduction you took that doesn’t have a receipt. Work with your tax professional to find a reasonable explanation as to why you took this deduction and why you don’t have proof so you can present it to the audit officer.
If the audit officer finds items that you cannot prove and you are not prepared to explain those items, you could run into the consequences of committing tax fraud depending on how big the issue is.
What Are The Possible Outcomes Of An Audit?
There are three possible outcomes of an IRS audit:
- The IRS is satisfied with the documentation you provided and no changes are proposed to your tax return. This is the most favorable outcome.
- The IRS proposes changes to your return based on the evidence you presented in your audit and you agree. In this case, you will sign an examination report or other form provided by the IRS and set up a payment plan in the event that you owe money.
- The IRS proposes changes to your return and you disagree. You can set up a conference with an IRS manager to review your case, or you can request a formal appeals conference.
Do I Need A Tax Professional To Help With My Tax Audit?
While it is not required that you work with a tax professional to prepare for your audit, it is advised that you hire someone for this process.
An experienced tax professional can tell you what to expect, help you find and organize your records, and even represent you at your actual audit.
Hiring a tax professional to help you prepare for or defend you in an audit can be expensive. However, it’s much better to have the knowledge and experience your professional will provide than to wing it on your own and risk making a fatal error.
The consequences of an audit are too serious to not hire a tax professional.
How Can I Protect Myself From Future Tax Audits?
In the case of randomly selected audits, there’s no way you can prevent a future audit from happening.
However, keeping thorough records and carefully checking over your entire tax return before you file it can help the audit process go quickly and smoothly if you are selected.
Additionally, always be sure that you are completely truthful and forthright on your tax returns each year. Only take deductions for which you qualify and have proof, and report all your income.
Do not try to doctor your taxes so that you owe less or get a refund. The IRS will find out, and the penalties can be severe.
If you feel uncomfortable capably preparing your own tax returns, work with an accountant or other tax professional to prepare and file your taxes each year. This reduces the risk that there will be errors made that get your return flagged for audit.
Worried About An Audit? Contact A Tax Audit Professional
Being the subject of an IRS audit is stressful. You want a tax professional who can help reduce your fears and help you feel fully prepared for what’s ahead of you.
At the Credit Review, we’ve compiled listings of all the most highly rated tax professionals so you can find the right firm to fit your needs. Get tax help today.
What is a tax audit?
A tax audit is when the IRS decides to take a closer look at your tax return and make sure that all the information (such as income and deductions) are correct.
What happens during a tax audit?
A mail audit will generally require that you send extra documentation (such as proof of donations). During an office or field audit, you (or your tax representative) will meet with the IRS agent to go over documentation and conduct an interview (if needed).
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