Preparing for an IRS audit can be a stress-free affair if you follow these best practices.
A Guide to IRS Audit Preparation
Step 1: Know What Triggers an IRS Audit
What does being audited mean?
An IRS audit does not mean you are suspected of undertaking a tax-related criminal activity. Sometimes it simply means you have been chosen by the computer screening and random selection system run by the IRS.
The IRS audit selection process takes its cue from a tested statistical formula. This compares tax returns under the same classification in order to arrive at what a “normal” account looks like.
The system singles out accounts that are out of the ordinary using the aforementioned “normal” tax returns. However, keep in mind even if your account qualifies as out of the ordinary, it does not automatically mean it’s legally problematic.
It could only be that you have entries in your tax return that require verification. The IRS might need to re-check your listed home office deductions, business use of a vehicle, rental losses, and hobby-related write-offs, to name a few.
Knowing why an IRS audit is done and how specific taxpayers are chosen will give you peace of mind. The whole process is not some kind of a witch hunt.
If your financial transactions are as transparent as they could possibly be, you have nothing to worry about.
Step 2: Know the Types of IRS Audit
An IRS audit comes in three different types, based on the severity of a particular case. The type of IRS audit you are scheduled to partake in should give you a hint on how severe your case is.
The first level of IRS audit is Correspondence, which takes care of simple issues such as misplaced paperwork or incorrect computations. It is done via mail and comprises three-quarters of all audits by IRS done within a fiscal year.
The second level of IRS audit is Office Examination, which verifies the accuracy of declared taxable income and the legitimacy of deductions. This IRS audit happens at a local IRS branch.
The third level of IRS audit is Field, which is the most thorough. A field IRS audit involves an agent visiting your accountant’s office or your place of business to examine tax-related records, for the purpose of verifying the accuracy of your tax returns.
Step 3: Know the Documents You Need for an IRS Audit
The IRS reaches out to taxpayers via telephone or mail, to inform them of an IRS audit. The agency does not send this notice via text or email.
A tax audit notice reflects everything you need to know about the process, including the documents you need to prepare. Usually, these documents include copies of the following:
- Pay stubs
- Home mortgage statements
- Brokerage statements
- Retirement account records
- Previous tax returns.
Make sure your prepared documents correspond with the specific year under the IRS audit. Remember to safe-keep the original copies of these records.
Ideally, you file all of your tax-related documents in one place and for at least three years after their corresponding fiscal year has expired. If you have yet to do this practice, it is best to start now.
For lost records, contact the agency for duplicates. You have 30 days upon receipt of an IRS audit notice to provide the agency with an appropriate response.
You may also want to consider speaking to a tax professional to fully comprehend the rationale behind the IRS audit to be conducted on your account.
RELATED: What Can You Write off on Your Taxes
Step 4: Know Your Rights During an IRS Audit
You can choose to either show up alone or with a tax consultant during the actual IRS audit appointment. You can also opt to skip the audit and be represented by a tax lawyer, a Certified Public Account (CPA), or an IRS Enrolled Agent.
Furnish the IRS with only the documents they have requested. Most importantly, be aware of your rights as a taxpayer.
These rights include the following:
- Confidentiality and privacy regarding tax matters.
- Representation, either by an authorized representative or oneself.
- Courteous and professional treatment by IRS staff and agents.
- To know the reason behind the IRS audit and the repercussions should the taxpayer fail to comply.
- To contest an audit report, both within the IRS and before the courts.
IRS Enrolled Agent Definition: A qualified person who can represent taxpayers before the IRS. Enrolled Agent status is the highest credential awarded by the IRS to a person.
Step 5: Know Your Legal Options After an IRS Audit
There are three possible outcomes after a tax audit. These outcomes include tax returns staying as is, tax returns changed as agreed upon, and tax returns contested by the taxpayer.
The first two outcomes do not entail any complications. The third outcome is where the whole matter gets a bit intricate.
After the tax audit, you will be provided with a detailed audit report. If you want to appeal this result, you can skip signing the report right then and there.
Instead, you can request your assigned IRS agent’s supervisor to conduct further review of your paperwork. You may also seek out help from the Taxpayers Advocate Service.
Should the outcome prove too severe, you can take your case to a Tax Court.
Alternatively, you may pay whatever tax deficiency the audit has revealed. This exempts your account from incurring interests and penalties, which could amount to 5% of tax payable per annum.
Meanwhile, if you are presently financially compromised, you can request for a payment extension, agree to an installment payment plan, or apply for an Offer in Compromise.
The IRS offers eligible taxpayers debt relief options and you might just qualify if you are able to prove your dire financial circumstance.
Don’t forget to download, save, or share this handy infographic for reference:
Want to know how to prepare for an IRs audit? Watch the video below and find out the things you need to do!
Being scheduled for an IRS audit does not automatically mean you are in trouble. So stay as calm as possible and make sure that you go into it with sufficient knowledge and preparation.
Have you experienced an IRS audit in the past? Please tell us your story in the comments section below.
If you owe back taxes, visit taxreliefcenter.org for more information on tax relief options.