Tax Audits & Legal Concerns
While many taxpayers find the notion of an audit intimidating, they happen at a much lower rate than you might imagine. The IRS has reduced the rate of audits over the last few decades due to a reduction in their staff and resources, combined with a shift toward focusing on services rather than enforcement. Most current audits occur through correspondence rather than in person, and the overall probability of being audited is less than one percent for any given taxpayer.
This does not tell the full story, though. The risk of being audited is higher for people in higher tax brackets. Meanwhile, people who earn very little income (less than $25,000) face a slightly higher risk of an audit than the average taxpayer because the IRS wants to make sure that they are not improperly claiming the earned income tax credit.
Risk Factors
Even if you are not at the very top or the very bottom of the tax brackets, you should not assume that you can cut corners on your taxes without consequences. The IRS applies certain computer algorithms to identify returns that seem suspicious. Some potential red flags include substantial deductions related to travel or casualty losses, deductions that seem unrelated to the nature of a business, or deductions that are very large compared to the income being reported. The IRS also may take a closer look if you are repeatedly claiming losses for a business, since it would be strange for a business that keeps losing money to stay afloat.
Employees need to make sure that they report their income accurately. The IRS will check the information on their W-2s against the income that they report on their tax returns. It may investigate further if those numbers do not match. It also checks 1099-NEC forms against the income that self-employed people report on their returns.
Going Through an Audit
The IRS has three years to conduct an audit after the date when the tax return at issue was filed, barring a finding of fraud or significant underreporting of income. If you are selected for an audit, your main goal is to show that you completely reported your income and did not claim any deductions, credits, or exemptions that did not apply to you. However, you should understand that you are likely to owe additional money to the IRS if you have been selected. You can feel free to ask for a postponement if you need more time to prepare your records or collect or reconstruct documents. Ideally, you should retain a tax professional to help you with this process. You should avoid holding the audit at your home or office if possible. Handling the audit at the IRS or simply having your tax professional do it for you tends to make the process easier.
You should make sure to research the law ahead of the audit so that you understand your rights. Having a basic knowledge of the law will help you prepare and present your records and object to any unfair actions by the auditor. (IRS Publication 1 contains the Taxpayers’ Bill of Rights.) If the auditor seems to suspect you of fraud, or if they otherwise seem hostile, you should consult a tax attorney or another tax professional. While you should respond truthfully to the auditor’s inquiries, you should not voluntarily disclose any more information than what the auditor is entitled to know. You should review the audit notice and bring to the audit only materials that are requested in the notice or that are relevant to the year being audited. The auditor is not entitled to review any other documents.
If you disagree with the results of the audit, known as the examination report, you can contact the individual auditor to question their findings. You can also try to reach a compromise with the auditor’s supervisor. If you cannot reach a compromise and stand to incur significant losses, you can consider the option of appealing in the IRS system or challenging the audit in tax court.
