Understanding Income Tax Audits

Elizabeth Rosen
by Elizabeth Rosen, Contributor

A Federal income tax audit is a review of your income tax return to determine its accuracy and truthfulness. Note that a tax audit is not necessarily an accusation of wrongdoing. By auditing you, the Internal Revenue Service (IRS) is basically allowing you the opportunity to prove or qualify the information you provided on your tax return.

READ: What to do if you receive an IRS audit letter

For example, consider the Federal tax deduction for charitable contributions. If you’ve indicated that you donated $1,500 to the Goodwill charity, it is up to you to produce the proper documentation to support your claim — in this case, you would likely need to provide a receipt signed by the Goodwill Store’s employee/recipient, as well as an itemized list of what you donated and its value. If you need help assessing the cost of your donation, both Goodwill and The Salvation Army offer fairly detailed “valuation guides” on their websites.

While preparing your income tax return, it is important to make sure you actually qualify for the tax breaks that you claim. If the IRS notices any discrepancies or misinformation, it’s almost guaranteed that you’ll be audited. The IRS will bring into question your tax credits and tax deductions, and you will be expected to provide sufficient documentation to prove them. Those who cannot supply the proper evidence for their claims will have to pay the difference in income taxes, plus any late fees and penalties.

If you receive a notice from the IRS that you’re going to be audited, do not panic. Make sure you first read the letter in its entirety to determine exactly what they’re asking you to do. Note that there are several different types of tax audits and you need to figure out which one applies to you. Depending on your situation, you may want to consider hiring a Tax Audit Defense Representative to help you navigate your case.

READ: Tax excuses the IRS won’t buy

There are some tax audits which are relatively pain-free. It may be as simple as providing your signature on tax form that you forgot to endorse, or sending in a tax form that you neglected to include ― this is referred to as a Correspondence Audit.

Other types of tax audits will require more effort to resolve. A Field Audit usually occurs at your place of business or at your representative’s office.  You will be asked to provide supporting documentation for the areas in question. Make sure that your income tax records are neat, thorough, and in order.

An Office Audit is held at the IRS office specified in the letter you received. In this case, you (or your representative) are required to attend a meeting where you’ll need to provide the specific tax information/documentation identified in the IRS’ letter. Bring only the documents and supporting information which have been specifically requested.

Within 30 days of an income tax audit, the IRS will provide you the opportunity to either agree with the auditor’s findings or file an appeal (within a specified timeframe).  If you agree with the auditors findings and you owe additional income tax, you must immediately pay that tax along with any interest or penalties due.

READ: IRS red flags you should avoid waving

On the other hand, if you disagree with the auditor’s findings, you have the option of making an appeal with the IRS Appeals Office. If you still fail to reach an agreement there, you can take your income tax audit appeal to the U.S. Tax Court, U.S. Claims Court, or U.S. District Court.

When dealing with an IRS tax audit, it is very important to remember that you must respond within the timeframe specified in the letter. To avoid getting audited in the future, do your best to keep good financial records and make sure the information on your income tax return is as accurate as possible.