We all get those emails from the post office showing us what is in our mailbox. Today starts out as any other day, except you see the all-to-familiar IRS logo in the upper left-hand corner of an envelope. Oh man – what could it be? Your heartrate picks up . . . you call your spouse to run out to the mailbox and check.
Congratulations, you’ve won the lottery!
The IRS audit lottery, that is.
If you’re being audited by the IRS, you’re in a very select group. Since the IRS audits less than one quarter of one percent of all income tax returns – that’s less than 1 out of 400 – it’s very exclusive company indeed.
Of course, this isn’t a prize that you wanted to win, and probably weren’t prepared for. If you’ve won this no-prize, here are three simple steps to help you prepare for your audit.
- Understand the depth of the audit.
There are three distinct levels of IRS audit, characterized by the depth of the government’s investigation into your financial life. Understanding the level of the probing you’re about to experience will help you determine how to handle it.
The first level are the mail audits. These are conducted entirely via the mail – you’ll never meet or speak to an IRS agent. These usually involve math errors and missed forms, such as a W-2 from a second job that you forget to enter when you file your tax return. The IRS will request clarification from you, and it usually requires just writing a letter back that contains the information they need. The vast majority of IRS audits fall into this category.
The next level up is an office audit. These are conducted by relatively low-level IRS agents at local IRS offices around the country. They conduct a basic verification of your income, deductions, and credits to make sure you’d done everything correctly.
The next level is the nasty one, the field audit. These are conducted by higher level Revenue Agents that visit you at home or your business, and their job is to fully verify everything you’ve claimed. They take an in-depth look at source records – we’re talking individual receipts, invoices, bank statements, etc. In the extremely unlikely event that you’ve won a visit from a Revenue Agent for a field audit, we highly suggest having the audit conducted through our office.
The notice that you receive from the IRS will explain what level of audit you’re facing.
- Determine exactly what the IRS is questioning.
Once you understand the depth of examination you’re being subjected to, you next need to understand exactly what on your tax return the IRS is questioning. In the majority of audit situations, the IRS is looking to verify one specific thing.
If you’ve received a letter from the IRS that requests you write them back with copies of specific documentation, you’ve been selected for the simple mail audit. The most common issues that come up in a mail audit involve various tax credits, medical expense deductions, charitable contributions, and education expenses. A whopping ¾ of all IRS audits are conducted this way, and revolve around a single issue on the tax return that the IRS is looking to validate.
For office audits, you’ll receive a request to visit an IRS office near you. These types of audits usually cover questions about income sources that don’t have much of a paper trail, such as tips and rents. They also commonly come up for business expenses that are hard to validate, questions about the value of property, casualty and theft losses, and capital gains tax matters. You have a legal right to have a representative with you at the IRS office for this kind of audit, so don’t go it alone. We can help you understand what the IRS is trying to determine, and show up on your behalf.
For a field exam, you’ll be requested to schedule a time for the Revenue Agent to come to you. These are the most complex audits, and the Revenue Agent will dig into your actual recordkeeping system. Field audits are expensive for the IRS to conduct, so they typically involve people with complex tax situations. Again, we highly recommend scheduling this type of audit at our office, since the IRS agent is going to do a forensic accounting examination of your actual records.
- Supply necessary documentation.
For mail audits and office audits, which usually involve singular issues, the documentation you need to prove your income, credit, deduction, etc. will be fairly straightforward.
If you lack the necessary paperwork in your own files, you may need to obtain the documentation from other sources. For example, you may need to request copies of medical bills from healthcare providers in order to validate medical expenses you’re claiming. If the IRS is questioning the value of an asset, you may need to obtain something like an appraisal from a third party. Or perhaps you’ll need to obtain a tip record from your employer in order to satisfy an inquiry into whether you’ve reported all tip income or not.
For mail and office audits, supplying this documentation should satisfy the inquiry in most instances. If you’re unable to supply the documentation, but your position is reasonable, you may be able to provide a simple written or verbal statement about why you’re claiming something (or not claiming it). These cases are a bit more difficult to win, but there is plenty of precedent for them. So just because you don’t a paper trail for something, don’t give up – there is magic that can be worked.
For a full-blown field audit, the documentation puzzle is a whole different animal. The exact documentation strategy here can’t really be generalized, since the issues being investigated are always unique in these types of audits. We’ll work with you in these types of audits to craft a personalized strategy for defending yourself against the audit.
In conclusion, hopefully you can now see that not all IRS audits are scary. It really boils down to understanding exactly what it is that they’re after, and what depth of probe they’re going to conduct. Knowing those two things, it becomes much less stressful of an incursion into your life. If you are having a hard time contacting the IRS regarding the audit, you may want to reach out to the IRS Taxpayer Advocate Service as well.
Of course, no matter what level of audit you’re facing, from the extremely simple to the extremely complex, we’re here to help. If you get a nasty letter from the IRS, don’t panic – call us and we’ll work together to figure out a plan for you. Just schedule a time to chat here:
***By the way, don’t forget about the penalty issue . . . if the IRS determines you owe additional tax, they may assess you a pretty nasty understated income penalty. Even if you agree with the additional tax, it is always worth it to appeal the audit to have the penalties reduced. Don’t leave money on the table when it comes to the IRS.***