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 being audited by the IRS 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 its 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|
(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 Twenty Triggers for an IRS Tax Audit.
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?
The IRS will adopt either or both of the following methods to complete the audit.
- They may send you mail seeking answers to a set of questionnaires or they may ask you to furnish documents pertaining to income or deductions/exemptions claimed in the tax return.
- They may also conduct an in-person interview to review your tax records. The discussion may take place either at an IRS office (office audit) or at your home, place of business, or accountant’s office (field audit).
You can also seek for a face-to-face audit in case you think that on certain issues you need to explain personally or documents are voluminous and hard to send by mail. It should be noted that US Code 26 requires you to keep all records you used to prepare your tax return – for at least three years from the date the tax return was filed. During IRS Audit proceedings, some of those records may be sought by the IRS auditor.
Types of IRS Audits
Basically, there are three different types of examination that may be conducted when your case is selected by the IRS for audit.
- Audit By Correspondence: 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.
- 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.
- 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
Except as otherwise provided in this section, the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed (whether or not such return was filed on or after the date prescribed) or, if the tax is payable by stamp, at any time after such tax became due and before the expiration of 3 years after the date on which any part of such tax was paid, and no proceeding in court without assessment for the collection of such tax shall be begun after the expiration of such period. For purposes of this chapter, the term “return” means the return required to be filed by the taxpayer (and does not include a return of any person from whom the taxpayer has received an item of income, gain, loss, deduction, or credit
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 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
- 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.
- No time limit in case of delinquent non-filed tax returns or fraudulent tax return
- If you filed form 872, which is the consent form for extension of the audit.
What happens if you fail an IRS audit?
The IRS audit penalties are sever and harsh as IRS can apply an additional percentage to the amount of taxes you owe them which maybe as under :
- 20% or 40% penalty depending upon the kind of mistake on your tax return.
- 75% penalty: generally for more serious cases, like tax fraud.
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.
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.