The IRS Tax Audit Process Explained
Receiving notice of a tax audit from the Internal Revenue Service can be a nerve-wracking experience, but the tax audit process itself gives you time to prepare your documents and present a strong case. Having a working knowledge of the steps involved and how long they take can help to resolve some of the uncertainty and fear surrounding IRS audits.
Step 1: Receive an IRS Audit Letter in the Mail
Ahead of an audit, you will always receive written notice by mail—never by telephone, email, WhatsApp, or social media. The letter will include information about the tax returns that are being examined, the specific query the IRS has (or the scope of the audit, if it's more detailed), any additional documentation they would like to see, and whether the audit will be a correspondence audit, office audit, or field audit.
From the date that the letter is mailed, you will have 30 days to respond either by mail or by phone. This gives you time to find representation (which we highly recommend), arrange for a power of attorney, and gather the necessary documentation.
Which Tax Returns Can Be Audited?
Any tax return can be audited up to three years from the date it was due or the date it was filed—whichever is later. This period is referred to as the statute of limitations. However, IRS audits can be extended as far back as six years if:
You appear to have significant errors on your tax return.
You appear to have a pattern of improper reporting.
The IRS has reason to suspect tax fraud.
You have understated your income by more than 25%.
You are found or suspected to have undisclosed foreign income, overseas assets, or overseas bank accounts.
To be ready for an extended audit, you should keep business tax returns, statements, and receipts for six years.
How Tax Returns Are Selected for an Audit
Some IRS tax audits are a result of random selection. However, more often than not, there is a reason that a tax return triggered an audit.
You may have been selected for an audit because:
The IRS' computer system flagged your tax return as having a high likelihood of incorrect values or unreported income.
Your reported income, expenditure, or tax values didn't match the values submitted by associated parties (such as your employer, employees, or the bank).
The IRS is auditing someone you did business with and needs to cross-reference specific information.
You work in an industry that deals largely in cash.
You deal in cryptocurrency.
You have assets in a domestic or offshore trust fund.
You have an undisclosed offshore banking account or undisclosed international assets.
Small businesses and businesses that deal in cash are especially vulnerable to IRS audits. That's why it's essential to have meticulous, up-to-date bookkeeping and get professional help with your small business tax returns. If you're just getting started, try these tips for easier bookkeeping.
Step 2: Prepare the Requested Documentation
Now, you have 30 days (or 60 days if you request an extension) to prepare your documentation. For a simple correspondence audit, you may only need to send in a receipt or two as requested by the IRS auditor. However, for an office audit (conducted at your local IRS office) or field audit (conducted at your home or place of business), the documentation can be much more involved, covering things like:
A detailed examination of the deductions claimed
A detailed examination of business expenses, including the cost of goods sold
A detailed examination of income sources, compared to your company's expenditure and your perceived lifestyle
Because face-to-face tax audits can be more intimidating and make you vulnerable to answering incorrectly or disclosing more information than you need to, it's highly recommended that you arrange for an experienced tax professional to advise, accompany, and even stand in for you in IRS communications and meetings.
Representatives for IRS tax audits include tax professionals such as:
Enrolled agents
Certified Public Accountants (CPAs)
Tax attorneys
Because these professionals have a thorough understanding of tax law, they can help you navigate the process strategically to minimize any outstanding taxes you have to pay. Moreover, they will use terms that the IRS auditor understands, preventing any miscommunications or accusations of lying or misrepresenting the facts.
If you simply want the enrolled agent or tax attorney to advise you and accompany you throughout the IRS audit experience, you won't have to fill in any legal forms (aside from the contract of payment with the tax professional). To have the professional stand in for you completely, you will need to sign the power of attorney form (Form 2848).
Step 3: Present Your Documents
On the established date, you will present your documents in the following manner:
Correspondence audit: You will post your response and documents by mail.
Office audit: You or your representative will present your documents at the nearest IRS office. For example, a business owner in Jacksonville, Florida would most likely be asked to meet with the IRS agent at the Jacksonville IRS area office (and if the business owner has opted for Florida tax audit services, their representative will ideally escort them to the hearing).
Field audit: You or your representative will show the auditor your documents at your home or place of business.
According to the IRS' 2021 Data Book, 78.4% of audits were conducted entirely by mail and the remaining 21.6% with face-to-face meetings. This should reassure you that most audits are resolved without any face-to-face communication. However, it's still important to get professional advice when drafting your responses and attaching documentation to ensure that you don't end up owing the IRS more than you should.
When Tax Audits Turn Criminal
Some tax audits that begin simply can turn into criminal investigations if certain actions or activities are suspected. The most common triggers for a criminal investigation are things like:
Tax fraud
Tax evasion
Substantial amounts of unpaid tax
Undisclosed offshore bank accounts
Hiding foreign assets
Money laundering
Dealing in narcotics
If your case turns criminal for any of these (or other) reasons, the matter will be investigated by an IRS special agent and—if considered by numerous high-up officials to be a valid case—referred to the Department of Justice, tax division (if it’s a tax crime) or the United States Attorney. If convicted of a crime, you could be looking at severe penalties, including jail time. In the United States, there are around 3,000 criminal prosecutions for tax fraud every year.
Step 4: Receive Notification of the Audit Findings
After presenting your documentation, it can take several months to two years for the IRS auditor to examine your case and produce the examination report, known as the Revenue Agent's Report (RAR). This report includes:
Proposed adjustments to your tax return, if any
The amount of tax owed (Occasionally, but not often, audit subjects are due for a tax refund instead.)
Interest due on any outstanding tax
Penalties for:
Failure to file
Failure to pay
Failure to make estimated payments
Tax fraud
Step 5: Decide Whether to Accept or Challenge the Audit Findings
At this point, you can decide whether you agree with the examination report.
No adjustments. Sometimes—especially if a small business accountant handles your finances—there will be no adjustments needed.
Adjustments that you accept. If there are adjustments made and you agree that they are fair, you will sign the reports or IRS form and arrange for a payment plan to settle the outstanding amount.
Adjustments that you don't accept. If there are adjustments made that you want to challenge, you can arrange to meet with an IRS manager, request a formal appeals conference, or sue the IRS in the U.S. Tax Court.
Timeline for Appeals
From the time you receive the report, you have 30 days to appeal the assessment. If you need more time, you can request a 30- or 60-day extension, which is usually granted. It's important to be aware that interest and penalties continue to accrue if you decide to extend your time of appeal and you don't win the case. However, tax professionals have been known to reduce audit subjects’ liability significantly through the process of appeals.
Step 6: Resolution
Sooner or later, the tax audit process will be resolved. This occurs when:
You agree with the examination report.
You challenge the audit findings and reach a new resolution with the IRS manager, through the formal appeals process, or in the U.S. Tax Court.
If your case is simple and you agree with the report, the entire process could be over in a matter of months. For complicated cases or if you challenge the audit findings, you could be looking at a process that goes on for years.
Be Audit-Ready at All Times
Tax audits can be scary if your paperwork is not in order, but if you know how to report income and expenses accurately and keep detailed documentation, the tax audit process should be simple and quick.
Whether you've already received a notice of audit or you simply want to get your finances audit-ready, consulting with an experienced tax professional is the best way to make sure you'll come through the audit process unscathed.
