Gren Invest: Demystifying the IRS Audit Process
Any taxpayer would be intimidated by a demand letter from the Internal Revenue Service (IRS). “Audit” can be one of the scariest words that registrants face, but knowledge about it is extremely empowering. What is an IRS audit? An IRS audit is nothing more than a review or examination of an individual’s or organization’s accounts and financial information to ensure the information is being reported accurately per the tax laws, and to verify that the amount of tax reported was done so correctly. The IRS targets returns for audit using a range of methods, including random selection and computer screening. A return, for example, may be chosen for review if the figures reported on the return are out of line with statistics based on other returns. It is also important to keep in mind that being chosen for an audit does not necessarily mean a person did anything wrong. The process is meant to preserve the integrity of our tax system everyone should pay their fair share.
An audit is a process and can be managed if you approach it in an organized and methodical manner. The first contact letter from the IRS will clearly state which records are under examination, and will inform the taxpayer the nature of the audit (mail or in-person at an IRS office, or at the taxpayer's home or place of business). Preparation is paramount. This means you'll need to collect all pertinent forms, including receipts, statements of bills, legal papers and tax records that validate the items as they appear on your tax return. And by going through your return thoroughly in advance of sitting down with an auditor it will enable you to anticipate questions and keep clean, concise explanation for your finances. At Gren Invest, we feel that when you are well-informed about the process, it can take much of the mystery out of it and ensure that one of life’s more stressful undertakings remains under control. Knowing what the auditors are searching for and having everything documented will help you approach the process with more confidence, and a fair, accurate conclusion.
The result of an audit can go either way. In rare instances, the audit may not impact your tax amount at all. In still others the IRS will make a proposed adjustment which would mean more tax, penalties and interest. You should know that taxpayers have rights at every one of these stages This includes the right to professional representation, and the right to appeal the findings in an audit. If you are not happy with the result, you may be able to have a conference with an IRS manager, pursue mediation or appeal to the IRS Independent Office of Appeals. These rights give you the confidence to know that you are being treated fairly and that your case is being properly considered. Finally, while an audit requires that you be vigilant and cooperative it is a well defined process with rules and procedures and by empowering yourself with information the anxiety associated with such an event can be mitigated.
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The IRS performs different types of audits, and each comes with varying degrees of scrutiny. The most commonplace and least obtrusive is a mail audit when the I.R.S. mails you a letter requesting more information or documentation concerning certain items on your tax return (a common one, for example, is the itemized deduction category or certain credits). The second type is an office audit, which requires you to go into a local IRS office and bring copies of documents for an auditor to review. This is usually a more thorough process than an audit by mail. The most comprehensive is the field audit, which involves an IRS agent coming to either your home, office or accountant’s place of business and examining all of your records. Generally this is for more complicated returns.
There are many reasons that can lead to an IRS audit, and in some cases it’s simply random. The IRS employs an algorithm known as the Discriminant Information Function (DIF) to score tax returns according to statistical profiles. The higher a DIF score the greater the likelihood of errors and a possible audit. Financial red flags might consist of reporting incredibly high itemized deductions based the income level, possessing high business losses especially for multiple years in a row or making an exceptionally large quantity of cash transactions. Other triggers may include inconsistencies between the income you report and information received from third-parties, such as employers (W-2s) or financial institutions (1099s). Amending your return could also attract more attention to your account.
The IRS typically has a three-year statute of limitations to audit a tax return after it is filed. That is because they are usually only able to look at returns from the last three years. But this time frame may be extended in some cases. If your taxable income has been understated by at least 25% then the statute of limitation is extended to six years. And remember, there is no statute of limitation if you have filed a false return or not filed a return at all. This is why it is adviseable to maintain all the tax records along with their supporting documents for a minimum period of six years to be well prepared in case of audit.
As a taxpayer, you have certain rights during an IRS audit under the Taxpayer Bill of Rights. Among these is the right to explanation, whereby the IRS must describe why they are asking for particular items of information and how they are using them in their audit. You deserve high quality service and that's exactly what you should be given, quick response, polite & professional work. And, importantly you have the right to representation and designate an authorized individual like a certified public accountant (CPA), attorney or enrolled agent speak on your behalf. If you disagree with the results of an audit, then you have another chance to fight that decision in a separate arena. It is crucial that you know these rights, so you have the opportunity to a fair and equitable process throughout.
Losing receipts is certainly annoying, but it doesn’t necessarily mean you’ll lose a deduction in the event of an audit. Although original receipts are the ideal evidence, in some cases the IRS will accept secondary proof to prove your expenses. This evidence may consist of canceled checks, bank or credit card statements (description only), written logs, or photographs. If you don’t have a receipt for, say, a business meal, the credit card statement with that transaction and an entry in your calendar about the meeting’s business purpose might be enough. The point simply is to recreate the expense ledger as close to reality as you can. For future years, you might think about employing digital tools and apps to snap and catalog receipts as you get them, if only to avoid this problem entirely.
You can represent yourself in an audit, but hiring a good tax pro such as a Certified Public Accountant (CPA), an enrolled agent or a lawyer is generally money well spent. They are very experienced in working with the IRS and well versed in tax law. They can make sure your rights are protected, assist you in organizing and presenting your records efficiently, and deal with the auditor so the agency goes through them rather than contacting you directly. This may be able to alleviate much of your stress and save you from having to make sure that you do not say something wrong during the proceedings. For more complex scenarios, e.g., a field audit or a case with substantial potential liability, it is usually advisable and preferable to have professional representation to ensure the optimal result.
When the IRS audits you and finds mistakes on your tax return, it will send a report documenting its findings along with a proposal for changes to your tax bill. If you consent to the changes, we will ask you to sign an agreement form and we will close the case if what you owe is paid in full You can pay more than just the amount due (no interest or penalties) at that time. Popular penalties are those that are imposed “20%” or the accuracy-related penalty, which is usually 20% of any tax underpayment. If you don’t agree with the findings, you’re not obligated to sign anything. Instead, you can file an appeal of the decision. You may also be entitled to a conference with an IRS manager who can explain the decision, or you may appeal to the independent IRS Office of Appeals.
Yes, you definitely can appeal the findings of an IRS audit if you don’t agree with them. An appeal is intended to be a fresh/unbiased look at your case. If you don’t agree with the proposed changes after the audit, you can have a conference with the auditor’s manager. If you can’t come to an agreement, you can file a formal protest to the I.R.S. Independent Office of Appeals. This is independent of the audit division and seeks to resolve tax disagreements objectively. An appeals conf with good writeup is your shot to state your case and negotiate a settlement before you have to fight it out in the Tax Court of the us where it ends.
No technique can promise you won’t get audited, but by employing responsible and honest preparation procedures, you can markedly minimize your risk. Keep performance consistent with the income listed on your W-2s and 1099s, as inconsistency is a big red flag. Use common sense in taking deductions; don’t write off amounts that appear to be extraordinarily high for someone at your income level or occupation without adequate support. Check your math, and don’t make basic clerical mistakes. These mistakes can be minimized by filing your tax return electronically. Finally, keep detailed records throughout the year to back up every item on your return. There is no better defense against the IRS than a well-prepared t, fully documented tax return.
Both an IRS audit and a CP2000 notice are types of IRS review, however they vary in the scale and procedure involved. The IRS sends out a CP2000 notice (sometimes referred to as an “underreporter inquiry”) when your tax return doesn’t match the income and payment information reported by the third parties employers or banks, for example who provided you with forms such as W-2s or 1099s. The solution recommends changing a particular tax rate. An audit, by contrast, is a more thorough review of your return that may be wider in scope and can take place by mail, at an I.R.S. office or in the field. While a CP2000 deals with a specific data discrepancy, an audit can challenge the accuracy of your deductions and credits.