We get it, an IRS letter makes you queasy just thinking about it.
Everyone does. And that’s completely understandable when you see the statistics.
Last year alone, the IRS completed over 505,000 audits that resulted in $29 billion in recommended additional tax payments.
That’s billion with a B.
The good news is most audits can be avoided.
And if the IRS selects you for review, there are effective strategies to help protect yourself from the worst outcomes.
In this article, we’ll cover:
- Why does the IRS Audit Tax Returns?
- Common Audit Pitfalls
- How to Protect Yourself
- When to Get Professional Audit Help
Why Does the IRS Audit Tax Returns?
The IRS doesn’t audit returns randomly. They have a reason for every audit.
Simply put, the IRS audits to verify that you paid the correct amount of tax.
They run computer programs that screen every tax return for inconsistencies or red flags. Anything that doesn’t add up or look normal. Numbers that stand out compared to others in your income range.
The audit selection process is based on specific criteria the IRS is programmed to detect. Patterns in the data that may indicate errors or underreported income. By working with IRS audit defense experts, you can better understand why your return was selected and what steps to take to respond correctly.
For example, if your deductions are significantly higher than others with the same income, that’s a red flag. If your reported income doesn’t match what your employer or bank reports to the IRS, that’s another red flag.
If your tax return has multiple flags, that increases the likelihood you’ll receive that dreaded letter.
And here’s one more thing to consider…
Returns from higher income earners are audited much more frequently. The IRS has made it a priority to audit those with income greater than $10 million. But even middle-income taxpayers aren’t safe if their return raises questions.
Common Audit Pitfalls That Get Taxpayers in Trouble
The same errors pop up over and over again.
These are the top IRS audit mistakes.
- Math errors and typos.
- Omitting income that they already know about from W-2s and 1099s.
- Inflated deductions and expenses
- Exaggerated home office deductions
One thing most taxpayers don’t know, however, is that it’s often how you respond to the IRS when the audit letter arrives that gets you in the most trouble.
How to Protect Yourself When You’re Audited by the IRS
The odds are very low you will be audited.
The chances of being audited are remote. CNN reports that between 2013 and 2021 only 0.44% of individual tax returns filed were audited.
But if you are in that small percentage, your response to the IRS is critical.
- Respond to audit letters quickly. Ignoring the IRS will make the situation much worse. The IRS will simply make up the difference and start collections. You will have lost the right to dispute anything.
- Organise your records and supporting documents. Once you respond to the IRS, be ready to present all documentation for the items being questioned. Bank statements, receipts, contracts, anything that justifies your return.
- Answer only the questions they ask. Don’t volunteer additional information. Answer what they ask and no more. Telling the IRS unnecessary information can raise new questions.
- Know your rights during an audit. You have the right to representation. You have the right to appeal an IRS decision you don’t agree with. You have the right to know why your return was selected for audit.
Simple, right?
The problem is when people get audited they tend to panic.
Panic causes them to get defensive, which only makes the IRS more aggressive.
Next, you get nervous and start providing inconsistent answers or explanations. The last thing you want is to make it look like you are trying to hide something or you made a mistake.
Keep copies of everything you send the IRS.
Another important tip is to use certified mail when sending anything to the IRS. Send it priority mail with return receipt requested.
The bottom line is to keep meticulous records of everything that you send the IRS.
The Real Cost of Getting It Wrong
If you don’t come out okay on your audit, it can cost you a lot of money.
It’s not just the extra taxes you’ll have to pay, but also penalties.
The most common penalty is the 20% accuracy-related penalty. This is the easiest for the IRS to justify. If the audit determines you underpaid by $10,000, you’ll also owe a $2,000 penalty.
But it doesn’t stop there…
The IRS also charges interest on underpayments. And they calculate that interest starting on the day the original return was due. Not from the date the audit is over.
In other words, you could be on the hook for years of interest on taxes you may not have even realised you owed.
If the audit uncovers fraud, the penalties are much worse. The accuracy-related penalty increases to 75% of the underpayment. Criminal charges are very rare but possible if the IRS believes the taxpayer was intentionally trying to evade taxes.
So it should be clear by now. The cost of hiring professional help is almost always less than the cost of going it alone and making mistakes.
When to Get Professional Help
For most people, an IRS audit is a stressful experience.
You know you made a mistake on your return, but now you have to tell the IRS.
In many cases, people simply write a letter of explanation and send it with the amended return.
In other cases, the IRS will ask for specific receipts or explanations. People do that all the time and the audit is over.
This is correspondence audit, and it’s the easiest and quickest kind of audit to go through.
The problem is that most audits are more complicated.
If your audit is for more than one year. If there are multiple amounts in question. If there is a lot of money at stake. If there are complex business transactions. And finally, if there is any hint that the IRS may think fraud is possible.
If any of those situations apply to you, it’s time to think about getting professional audit representation.
Why Does It Matter?
Tax professionals know how to communicate with the IRS. They know what to say and how to say it.
They know which documents matter and which ones don’t. Often, they can fix things with the IRS without you even knowing there was a problem.
Most importantly, the tax professional becomes a buffer between you and the IRS. Everything goes through them. You never have to say or do the wrong thing or miss a deadline.
Summing Up the IRS Audit Defense Tips
Hopefully, you have seen that IRS audits are not the end of the world.
In fact, the taxpayers who survive audits without major issues are the ones who take them seriously from the very beginning.
Before we wrap this up, let’s review:
- Keep your tax records in order all year long
- Report all of your income accurately
- Only take deductions that you can document
- Respond quickly to all IRS notices
- Get professional representation for complex tax matters
- Never ignore the IRS
The best way to come out okay is to be prepared. By having your documentation in order and knowing your rights, you are in control of the process.
Don’t wait for the IRS to audit you before you start thinking about IRS audit defense.
The right time to prepare is now, well before you ever have a problem.
