IRS Audit : What You Need To Know to Protect Yourself From Costly Penalties & Legal Issues

The words ” IRS audit “bring anxiety and a cloud of hassles in every taxpayer’s mind, even if he/she knows there are no faults in their return. So, his question, ” What does being audited by the IRS mean?” requires a detailed answer. Theoretically, an IRS tax audit of your tax return is closely scrutinising your income declaration, your claim of exemptions , other tax deductions and tax credits specially earned income tax credit etc. Basically, the IRS checks whether your claim is correct and as per the US Code 26. The process of an IRS audit is frightening for many, and stories are full of anxious moments in the life of taxpayers.

What are the chances of being audited by the IRS?

Let us first examine the chances of the IRS audit in 2021 or 2022. Frankly, it is extremely low if we go by the past history of selection for audit numbers. Read below the US Treasury Report Number 2021-30-011 that says less than 1 % of the total return filed in FY 2018 were selected for IRS audit in FY 2019

Taxpayers filed more than 199 million returns during Calendar Year 2018, of which 771,095 returns (less than 1 percent) were examined in FY 2019. The number of returns examined has declined 44 percent since FY 2015, when 1.4 million were examined. The decline in examinations is the result of decreases in staffing. The number of IRS examination staff decreased 18 percent from 11,267 in FY 2015 to 9,198 in FY 2019.

Income wise selection of cases for IRS audit in 2020

The income-wise selection of tax returns filed for 2016 was selected for IRS audit through 2020 shows that the chances of selection of scrutiny of your tax return by the IRS are quite slim unless you have some grave errors or some other triggers for an IRS tax audit.

Adjusted Gross Income	Audit Rate
0	8.90%
$1- $25,000	0.70%
$25,000-$50,000	0.40%
$50,000-$75,000	0.40%
$75,000-$100,000	0.40%
$100,000-$200,000	0.40%
$200,000-$500,000	0.60%
$500,000-$1,000,000	1.10%
1,000,000-$5,000,000	2.50%
$5,000,000-$10,000,000	5.10%
over $10,000,000	8.60%

(Source: IRS Data Book, 2020.)

How does IRS select a return for an audit?

There are two methods of selecting cases ( tax returns) for IRS audit. The first is based on certain internal norms and parameters that are decided annually by IRS. In order to select some cases on the basis of those parameters, the IRS feed these norms and gets the computer to choose them on a random basis. Tax practitioners have identified twenty types of triggers for an IRS tax audit.

The second is based on some related issues or transactions with other taxpayers whose returns were scrutinized under an IRS audit earlier, and they find the same issue on the tax return of taxpayers. Please read in details about twenty such identified IRS audit triggers.

How does the IRS notify you of an audit?

The IRS will notify you about the selection of your tax return for audit by mail. There is no other way of informing the IRS audit selection. The IRS will provide all contact information and instructions in the letter telling you about the audit of your case.The IRS audit notice or intimation will have clear reasons for a review of claims or credits in the tax return for a particular tax year.

The IRS notice for audit will also have clear instructions on what they desire from the noticee (you) , including any additional information, clarification, or documentation that they need to complete the process and cut-off date (deadline) within which they need those information/documents.

How does the IRS conduct audit?

Basically, there are three different types of examination that may be conducted when your case is selected by the IRS for audit.

1. Audit by mail: Most common type of audit is done by mail. You may get a mail request from IRS for specific documentation to support particular items on the tax return.Watch this official video on IRS audit by mail.
2. Audit at your place: The IRS may choose to visit your home, place of business, or your tax professional’s office to perform the audit. This is the least common form of audit and is only used if the individual or company being audited earned well over $100K.
3. Office Audit: Under this IRS would like you to visit their office to meet with an IRS auditor. The IRS will determine the time and the particular documents that it would like you to bring for support.

How long does an IRS audit take?

Once the IRS selects your case for audit, the statute gives them 36 months to complete it. But since eight months are required by IRS for processing appeal, IRS has to complete the audit within 28 months from the date the audited taxpayer filed the tax return, or by the date, it was due, April 15, whichever is later.

Section 6501 of US Code 26 states so as under :

26 U.S. Code § 6501 – Limitations on assessment and collection

(a)General rule

For various reasons, IRS may only be able to complete the audit after three years. In such cases, IRS may extend the audit time. Although you are within your rights not to agree to an extension of the audit period, it is generally advised to accept or at least negotiate about the time of extension, keeping several factors like

• more time to provide further documentation to support your position;
• more time to request an appeal if you do not agree with the audit results; or
• to claim a tax refund or credit.

How far back can the irs audit ?

IRC 6501 provides the time limit for IRS audit up to three years after due date of filing the tax return or the date of filing the original return , whichever is later. However there are three exceptions to this statute

1. If income was under-reported by more than 25 per cent, IRS has six years to conduct an audit and assess additional taxes if warranted.
2. No time limit in case of delinquent non-filed tax returns or fraudulent tax return
3. If you filed form 872, which is the consent form for extension of the audit.

What happens if you fail an IRS audit?

Failing an IRS audit can result in several types of IRS audit penalties, depending on the severity of the noncompliance and the specific tax issue involved. Here are some of the most common penalties that taxpayers may face if they fail an IRS audit:

1. The Accuracy-related penalty is imposed when a taxpayer makes an error or omission on their tax return that results in an underpayment of tax. The penalty is usually 20% to 40% of the underpayment amount.
2. The failure to file penalty is assessed when a taxpayer fails to file their tax return by the due date, including extensions. The penalty is usually 5% of the tax owed for each month or part of a month that the return is late, up to a maximum of 25%.
3. The failure to pay penalty applies when a taxpayer fails to pay the full amount of tax owed by the due date. The penalty is usually 0.5% of the unpaid tax amount for each month or part of a month that the tax is late, up to a maximum of 25%.
4. Civil fraud penalty is assessed when a taxpayer engages in fraudulent activity, such as intentionally failing to report income or claiming false deductions. The penalty is usually 75% of the underpayment amount and can be accompanied by criminal charges.
5. In extreme cases , when IRS audit suggest and charges the tax payer of tax fraud or tax evasion, taxpayers may face criminal charges, including fines and imprisonment.

What to do if you do not find IRS audit ?

If an IRS audit proposes an adjustment to your income that you find incorrect, you can request a conference with an IRS manager. The IRS also offers mediation which is an informal and confidential dispute resolution process.Lastly you can file a protest to the order passed by the Audit officer to Office of the  appeal .

What records IRS may seek during an audit ?

It depends on the reasons for IRS audit. For example, say , your tax return was selected for scrutiny on the ground of your claim of a tax credit which falls among folllowing five types of credits (These are among most common reasons for IRS audit )

• Earned Income Tax Credit (EITC)
• Child Tax Credit (CTC)
• Additional Child Tax Credit (ACTC)
• Premium Tax Credit (PTC)
• American Opportunity Tax Credit (AOTC)

Why do IRS audit when you claim any of these five tax credits ? Because their own records may reflect some kind of mismatch or suspicion that either your child is not a qualified child as per law for the specific credit or IRS records point that someone else has also climed same child for a credit. So, IRS may seek documentary evidence of relationship with the child ,proof of residency and any other that fits their scrutiny for the tax credit claims.

Similaraly , if IRS is conducting any audit for any business exepense , they may seek one or many of the records as listed on its website.

IRS audit infographic

Can you go to jail for IRS audit?

When IRS audit concludes that taxpayer was involved in tax evasion or tax frauds , they bring in criminal charges against the tax payer. That is the occasion , which is very serious one and one can go to jail if the charges levied by The IRS auditor is proved in a court. Naturally ,in such situation , you need to hire tax attorney who can , depending on the error(s) found during an audit, can defend your case and may even convert it to a case of penalty and not the prosecution.