In 2016 the IRS audited nearly 1.1 million tax returns. That’s about 0.5% of all tax returns.
While it’s a small percentage, a tax audit is always a possibility. One way to make it less of a possibility is to understand and avoid certain IRS audit triggers.
Also, if you do end up being one of the unlucky 0.5%, it’s important to know what to expect during an IRS audit and what you can do to speed up the process.
We want to help you handle a difficult and stressful process with more ease. Keep reading to learn everything you need to know about the IRS tax auditing process.
What a Tax Audit Is
Every year, the IRS chooses to audit certain tax returns. They are looking to verify that the income and deductions you claimed are accurate and legitimate.
It’s a smart idea to always keep your financial documents organized. This will help you prepare for taxes and will make the auditing process easier.
How do you get audited? There are three different types of audits the IRS performs:
- Mail audits
- Office audits
- Field audits
It’s important to note that no matter which type of IRS tax audit, the IRS will never reach out to you via the phone or email. You will only ever receive notifications from the IRS through the postal service.
A mail audit is the easiest type of audit. You do not have to meet with an auditor in person.
Instead, the IRS will ask you to send additional documentation to help back up the claims you made on your tax return. If you claimed a certain amount in deductions for charitable contributions, the IRS will ask for a letter which verifies those donations.
An office audit happens at a local IRS office. You’ll meet face-to-face with an auditor and they’re more in-depth than a mail audit.
You’re allowed to bring a lawyer or accountant with you to these meetings. Be prepared to answer questions regarding your return.
You’ll also be asked to bring along specific information to back up your claims. Often these include receipts and banking or other types of documentation.
A field audit is the most serious and complicated of all the audits. This type of audit takes place in your home or office.
These audits happen when the IRS needs to investigate more than just a deduction or two. Instead, a field audit is extremely thorough and will most likely cover every item listed on your return.
Outcomes of Audits
There are only three possible outcomes of an IRS audit.
- No changes
- Changes you agree with
- Changes you disagree with
If you provide all the documentation to the satisfaction of the IRS, there will be no changes to your tax return and they’ll close the matter permanently.
However, if the IRS recommends changes, you can either agree with them or disagree with them. If you agree, you’ll have to sign a form provided by the IRS. You’ll also have to enter in a payment arrangement with them.
When You Disagree With the Outcome
In cases where you disagree with their assessment, you have two choices. Your first option is to set up a conference with an IRS manager who will take another look at your case.
Your second option is to request a formal appeals conference.
Common IRS Audit Triggers
There are several IRS audit triggers that make you more likely to receive a notice from the IRS. There are also several myths regarding triggers you should be aware of.
Here are some common actual triggers:
The IRS uses a computer system known as the Discriminant Information Function (DIF) that scans every tax return the IRS receives. DIF looks for things like duplicate information, deductions, and credits that don’t make sense.
They compare your return to other taxpayers who earn around the same amount in income. If your return is flagged, it then gets reviewed by a human IRS agent.
The IRS gets copies of your W-2 or 1099-MISC forms. If you receive income from interest or dividends, the IRS also gets a copy.
Even if you hit the lottery or win at a casino, the IRS will receive form W-2G. If you fail to report this income, the IRS will know and may likely proceed with an audit.
Claiming Too Many Deductions
Living beyond your means or claiming a lot of deductions for a large amount of your income often triggers an audit. If you try to claim a lot of your income goes towards your mortgage but you don’t earn enough to qualify for that mortgage amount, it’s a good chance your tax return will be flagged.
Dipping into your retirement fund early and not paying taxes on it will definitely raise a red flag.
If for any reason you choose to give away items valued over $500, get them appraised and then submit Form 8283 with your tax return.
Self Employment Red Flag Deductions
While there are great deductions allowed for self-employed individuals, going too crazy on the deductions can definitely trigger an audit.
If you’re a hair stylist, chances are you don’t need to travel much for your work. If you’re claiming you spent 50% of your time traveling and you only work in one salon, that’s a red flag.
Keep All Receipts
If you do legitimately travel for work, always keep receipts for meals, entertainment, travel, and lodging. Write on the receipt who you met with or keep a journal. You may also have to supply written letters from those you met with to legitimize your claim.
Home and Cash-Based Businesses
Some business owners use their home as their office. However, the rule is that the space you claim on your taxes can only be used for business purposes.
Cash businesses also are often a red flag. It’s really easy to pocket $50 in cash rather than reporting it the IRS. Typically, the only way you get caught is if someone reports you to the IRS for driving a Jaguar when you’re only claiming you earned $40,000 from your business.
You Can Survive a Tax Audit
A tax audit can seem especially frightening to someone who is struggling with money already. However, the IRS isn’t out to destroy you.
If you owe money to the IRS there are several solutions you need to know about. Click here to learn about IRS debt forgiveness options.