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Do you know one of my least favorite return addresses to find in the mailbox? Internal Revenue Service.
As a freelancer who often owes on her taxes at the end of the year, it’s not all that unusual for me to get notices from the IRS. But still, my stomach sinks every time it happens.
The IRS, with all its red tape and difficult-to-understand notices, can be intimidating. But it’s especially scary if you’re selected for a tax audit. Don’t worry, though; we’re here with a step-by-step guide on what you should do if you get that dreaded audit notification.
Related: Credit Karma Tax Review
First up: What is an audit, and why are you selected?
An audit is basically an in-depth review of your financial information and accounts to ensure that you’re reporting your taxes correctly. Some businesses (and most non-profits) undergo regular audits from third-party accountants to make sure that their books are up-to-date. But it’s less typical for an individual to undergo an audit.
Chances are that if you get audited, you’re not necessarily expecting it. And the IRS is likely to be the third party combing through all your highly-personal financial information.
So, just why might you be subject to an IRS audit?
Many times, being audited doesn’t necessarily mean there’s a problem with your taxes. The IRS uses a computer and a statistical formula to select tax returns for auditing. Some tax returns are audited randomly. Others are chosen because something on the return triggers the computer’s audit-suggesting algorithm. Even if something in your return causes the algorithm to select you for an audit, though, the problem could be a minor one. Or there could be no genuine issue at all.
You may also be audited if a business partner or investor is audited. If someone with whom you’ve had business transactions is audited, you may be audited as part of their audit. Confusing and not entirely fair, but that’s the way things are.
If you worry about being audited as soon as you push send on your e-file returns, don’t. Your chances of being audited, especially as an individual, are very slim. In fact, in 2020, the data show that only 0.5% of individual tax returns were audited!
What’s most likely to trigger an audit?
If you file your taxes using many of the popular online software options, you may get an audit risk assessment before you file. The software combs through your tax return to find items that may make you more likely to be audited.
Simply getting a tax return doesn’t necessarily make you more prone to an IRS audit. But some situations do make an audit more likely. These include:
- Reporting no income
- Reporting more than $10 million in income
- Filing an estate tax return for assets worth more than $5 million
- Filing an international return
Budget cuts in the IRS have left the department less able to conduct audits. So, they want to put their resources where it counts, auditing individuals who are most likely to wind up owing the government more money.
One thing to note here: mathematical errors aren’t likely to trigger a full tax audit. The IRS does check returns for basic mathematical errors. While the IRS code is confusing, the basic procedure in the event of a math error is that the IRS will correct the error and then adjust your return for you.
You’ll get a notice if you owe more money because of the math error once it’s corrected. In some cases, you may need to amend your taxes. Usually, though, the IRS will just correct the mistake for you and then give you notice of any fallout.
Note that if you do get a notice that you owe more money or are getting a smaller return than expected, your online tax filing software may refund you the difference. Most of the popular options today have accuracy guarantees that protect you in case the software makes a calculation error.
7 steps to deal with an audit
With all that said, let’s get down to how to deal with a tax audit, should one happen to you.
1. Look for a letter, NOT a phone call
If you get a phone call from someone claiming to be the IRS, it’s most likely a scam. The IRS will contact you about an audit—or anything else, for that matter—by mail. So, don’t give up any personal information over the phone to someone claiming to be an IRS representative.
2. Gather your documentation
While IRS letters can be somewhat confusing, they will tell you exactly what you need to provide. The IRS will ask for documentation of records that they might require. This could include receipts, bills, legal papers, canceled checks, tickets, medical or dental records, loan agreements, employment documentation, and more. Here’s a full list of documentation the IRS might request.
You may not have to provide all the documentation you used to file your taxes, but you’ll need to support the credits or deductions that you claimed on your tax return. The notice you get from the IRS will tell you exactly which records you’ll need.
When gathering your records, be sure that you only present records from the relevant tax year(s). Organize them by year (if more than one is in question) and type of income or expense. It’s also a good idea to offer a summary of transactions, which will make your records easier and faster to sort through.
3. Respond to all notices in a timely fashion
Each notice you get from the IRS will include a timeline for your response. After the first audit notification, you’ll have thirty days to respond. Be sure to respond to the IRS as quickly as possible. If you wind up owing money due to the outcome of your audit, your interest owed will just keep adding up. The longer you take to respond, the more money you’ll have to pay.
You’ll need to respond either by mail, for smaller items, or in an in-person interview. If the IRS requests information by mail, you can always request a face-to-face audit. If you do mail tax records to the IRS, consider asking the US Postal Service for confirmation of delivery so that you can ensure you’re meeting the proper timeline
4. Ask for more time, if you need it
It’s important to fulfill the IRS’s requests as soon as possible. When you have unpaid taxes, whether because you haven’t filed or because of a mistake discovered during an audit, you owe interest on the unpaid tax from the date of the return until you pay it off in full. There are some caveats in cases where the IRS doesn’t notify you of an issue. But the faster you resolve the problem and pay off any balance owed, the less money you’ll pay.
However, if you need more time, you can ask for it. If your audit is being conducted by mail, you can fax or mail your request to the IRS office. Usually, you can get a 30-day extension without much effort. But if you need more time beyond that, extensions are granted on a case-by-case basis.
If your audit is being conducted in person, you’ll need to connect with your auditor or your auditor’s manager to get an extension.
5. Consider enlisting help
You have a right to representation by an authorized representative when it comes to a tax audit.
But should you pay a professional to help with your audit? That likely depends on how complex the problem is, and what other assistance you have available. Depending on how you filed your taxes, your filing service may provide some assistance.
For instance, Turbo Tax provides audit assistance to customers who paid for the service at the time of their tax filing. H&R Block also provides similar services. Many tax software programs offer audit help centers, where you can at least get your questions answered throughout the process.
First, my advice is to see what resources are already available to you through your tax preparation software or other avenues. Then, if you’re still struggling to come up with the proper documentation or if you disagree with the audit’s findings, consider hiring additional help.
If your audit is complex right from the start, though, you might consider skipping straight to hired representation who can help you answer the IRS’s questions appropriately and promptly.
6. Understand possible outcomes
There are three potential outcomes for an IRS audit: no change, agreed or disagreed.
If there’s no change, you’ve provided everything the IRS needs, and your tax return stands as originally submitted. If it’s agreed, the IRS proposes changes, and you understand and agree with them. If it’s disagreed, the IRS proposes changes, but you disagree with them. If you disagree with the audit findings, you can request a conference with a manager or file an appeal.
In this case, you’ll certainly want legal representation to help you argue your case higher up the proverbial food chain.
7. Pay up quickly if you owe
If you get to the end of an audit or an appeals process and you owe money, make arrangements to pay it as quickly as possible. Remember, the longer your balance is outstanding, the more you’ll owe in penalties and interest. And if you refuse to pay for long enough, you could face a federal tax lien or a levy of your property.
Your best bet is to pay the balance in full as soon as your audit is concluded. But if this isn’t possible, contact the IRS as quickly as possible about getting on a payment plan. Once you sign an installment agreement, you can start paying the balance you owe. You’ll still pay interest, but you’ll avoid the heavier issues like liens and levies.
While the word audit strikes fear in the hearts of many, especially this time of year, it doesn’t need to be terrifying. Just remember that a very, very small fraction of individuals will have their returns reviewed, so the odds are with you.
For those who are audited, you may not have even done anything wrong—it could have just been the luck of the draw. Submit any requested documentation to support your return (which you should be keeping for at least three years) as soon as possible. Utilize any resources that your filing software may provide, and be sure to respond promptly. If you do end up owing, pay up quickly to avoid extra interest.
The chances of getting audited are pretty slim for the average Joe. If you’re one of the unlucky ones, though, know that you’ll be alright. Hopefully, these steps will help get you through the process!
Have you ever had a tax return audited? What was the outcome, and was it as bad as you’d feared?