How an IRS Audit Works

An IRS tax audit is the reexamination of tax return by the IRS to look for errors made by the taxpayer in the preparation of the return. An audit can be as simple as correcting an arithmetic error or as complex as a complete review of one or more tax returns. The IRS selects less than one percent of tax returns for audit. 

How does the IRS select tax returns to audit? While the IRS does not publish the exact criteria used to determine which returns to audit, tax expects have identified a number of “red flags” that may lead to an audit. Some of the major “red flags” that may result in a tax return being selected for audit include:

*Under-reporting of income

*Claiming the home office deduction

*Claiming charitable contribution deductions that are unusually large for the taxpayer’s income level

*Deducting a business loss for a hobby activity such as car racing or horse breading

The IRS also randomly selects some returns for audit. 

Once the IRS has selected a return for audit, the IRS will notify the taxpayer. The IRS usually gives notice by mail, but notices are also sometimes given by telephone. The notice will inform the taxpayer what is being audited, when and where the audit will take place if the audit is to be done in person, and what documents and records the taxpayer needs to produce at the audit. 

In the notice, the IRS will inform the taxpayer of the scope of the audit and the issues involved. The scope of IRS audits range for an audit of a specific entry on a single tax return to the complete review of multiple tax returns. Generally, the greater the audit’s scope, the longer the audit will take to complete and the more documentation the taxpayer will be asked to provide. 

The notice from the IRS will also specify the location and time for the audit. Audits may be conducted by mail for minor issues or at an IRS field office (office audit) or at the taxpayer’s home or place of business (field audit). The taxpayer may request the IRS to change the time or location of the audit; however, the IRS is not required to do so. 

The IRS will also send a written request for any documents that it wants to the taxpayer to produce at the audit. The Internal Revenue Code requires taxpayers to retain the records used to prepare their tax return for at least 3 years after filing the return. The IRS will specifically notify regarding which documents to produce and it is usually not in the taxpayer’s best interest to produce more documents than those requested by the IRS. 

The taxpayer is entitled to representation at the audit. The taxpayer may be represented by an attorney, a certified public accountant, or an enrolled agent authorized to practice before the IRS. If the taxpayer has professional representation for the audit, then the taxpayer may not be required to attend the audit. The issue of whether the taxpayer needs to attend the audit is usually negotiated between the taxpayer’s representative and the auditor.

At the audit meeting, the auditor will review the documentation provided by the taxpayer. Additionally, the auditor may ask questions regarding the preparation of the tax return. Depending upon the number and complexity of the issues involved, it may be necessary for the auditor to conduct additional audit meetings.   

After concluding the audit meetings and reviewing all the requested documentation, then the auditor will may a determination of the outcome of the audit. The auditor may find that the taxpayer has substantiated all items in question and find that no changes to the return are required. Alternatively, the auditor can find that changes are required to the return. If the auditor finds that changes are required, the taxpayer can either accept the auditor’s findings and pay any additional tax, or appeal the auditor’s decision.