Understanding Tax Audits: What to Expect

When the Tax Man comes knocking

The prospect of a tax audit is something that understandably instills fear in many people and is something that most would prefer not to have to think about. However, it is important to understand how tax audits work and how to be prepared for them. This process involves a thorough examination of financial records and tax returns to verify their accuracy. In this article, we'll delve into the key aspects of tax audits, shedding light on the process, triggers, and what to expect.

Triggers for a tax audit

A tax audit can be initiated for various reasons. Some common triggers include discrepancies in tax returns, unusual deductions or credits, and random selection by tax authorities. In some cases, information received from third parties, such as financial institutions or employers, can also lead to an audit. It is important to understand that just because you are being audited, does not necessarily mean that there is something wrong with your return. It may just be that your return was randomly selected and the IRS wants to verify certain items. You may also have an unusually high amount of deductions or credits claimed on your tax return that the IRS wants to ensure the legitimacy of.

Types of tax audits

No matter which type of audit you are subject to, the process will always begin with you receiving notification of the audit by mail. There are then three main types of IRS audits to be aware of.

Mail Audits

Mail audits are the most common and least intrusive type of audit that the IRS conducts. The IRS will typically request specific documents from you to substantiate various items on your return. As an example, if you took a $20,000 deduction on office equipment placed in service during the year, the IRS may ask that you provide them with receipts and/or bank records. In most cases, simply submitting the requested items to the IRS will conclude the audit in your favor.

Office Audits

Office audits are in-person affairs that are conducted at your local IRS office. These audits are typically lengthier and will include questions about your return from an IRS agent. You will be provided with specific instructions on what to bring to the meeting such as the accounting records for your business or any specific bank statements or receipts. One important thing to understand with field audits is that you have the right to bring your accountant or lawyer to represent you at these meetings. This is generally a wise course of action to take, particularly when there are large sums of money at stake.

Field Audits

Field audits are the most extensive and detailed audits that the IRS conducts. Field audits will involve an IRS agent conducting an audit at your place of business or at your home. Field audits are generally conducted when the IRS has significant doubt about the accuracy of many different parts of your tax return.

How to prepare for a tax audit

Undergoing a tax audit can be daunting, but preparation is key to achieving a favorable result. Below are some tips for a successful tax audit experience.

Gather documentation

Organize and compile all relevant financial records and tax documents, ensuring they are complete and accurate.

Seek professional assistance

Consulting a tax professional can be invaluable in navigating the audit process, as they can provide guidance and represent you before tax authorities.

Review tax returns

Carefully review your tax returns to understand any potential discrepancies or errors that might need to be addressed. Consult your tax professional as needed.

Maintain open communication

Keep lines of communication open with the auditor, responding promptly to any requests or inquiries during the audit.

Potential outcomes of a tax audit

The outcomes of a tax audit will depend on the findings and the taxpayer’s response. The possible outcomes of the audit are listed below.

No changes

If the audit process confirms that the tax return was accurate as originally filed, there will be no changes made and no balance due.

Additional taxes owed

If discrepancies are found or if the taxpayer cannot substantiate certain deductions on the return, the taxpayer may be required to pay additional taxes, penalties, and interest.

Refund due

In some cases, an audit can actually uncover discrepancies in favor of the taxpayer, resulting in a refund of overpaid taxes.

Appeals process

If the taxpayer does not agree with the results of the audit, they can challenge the result through an appeal. They are then able to provide additional evidence or arguments.

Criminal charges

This outcome is rare but in cases of severe tax fraud or evasion, criminal charges may be pursued against the taxpayer.

This article was written and reviewed by Chad Gaines, CPA