An IRS tax audit might sound intimidating, but it’s simply a detailed review of your tax return to make sure it’s accurate. There’s no need to stress; just focus on being fully prepared, as that’s the best way to navigate the process and ease your concerns.
You’d be surprised to know that the IRS audited less than 0.4% of individual tax returns in 2022. And most of them were for discrepancies or questionable claims in filings.
So, if you’re facing such a situation, we’ll help you prepare for it. Read ahead.
What is an IRS Tax Audit?
An IRS tax audit is a review process in which the Internal Revenue Service (IRS) examines your tax return to ensure that the information you provide is accurate and complies with tax laws.
This doesn’t necessarily mean you’ve done anything wrong; audits are often conducted randomly or triggered by inconsistencies in your return, such as unusually high deductions or mismatched income figures.
The audit process aims to verify details like income, expenses, deductions, and credits. It can be conducted through mail (correspondence audit) or in-person meetings (field or office audits).
Most audits are resolved by providing the IRS with additional documentation to confirm the accuracy of your tax return. Proper preparation and addressing accounting challenges can greatly help in resolving these audits.
Five Common Reasons for an IRS Tax Audit
Here are a few reasons why you might be called in for a tax audit by the IRS:
1. Discrepancies in Reported Income
The IRS matches the income you report with information provided by employers, clients, or financial institutions. If there’s a mismatch, such as unreported income in Form 1099 or W-2 form, it raises a red flag.
According to the IRS, underreported income is one of the top reasons for audits, contributing to an estimated $352 billion tax gap annually.
2. Unusual Deductions or Credits
Claiming deductions or credits higher than your income level can raise red flags and trigger an audit. For instance, excessive business expenses for a relatively low-income business can prompt scrutiny.
3. Failing to Report All Income
Income from freelance gigs, rental properties, or investments must be reported. Even small amounts are subject to tax. The IRS receives copies of all 1099s and W-2s, so failing to include any of these on your return can lead to an audit.
4. Claiming Generous Charitable Donations
While charitable donations are tax-deductible, claiming contributions far above what’s typical for your income bracket can draw unwanted attention. The IRS typically expects charitable donations to be under 15% of gross income. Exceeding this, especially without proper documentation, increases the likelihood of an audit.
5. Using Round Numbers in Expenses
Listing expenses as rounded figures (e.g., $5,000 for travel or $3,000 for meals) can seem fabricated or imprecise. Actual expenses rarely end in zeros, as we don’t always round off while buying a meal or going on a vacation. This simple mistake is a more common trigger than people realize, particularly for small businesses or self-employed individuals.
Five Simple Steps to Prepare for an IRS Tax Audit
You might feel a bit overwhelmed the first time you’re asked to appear for an IRS tax audit. But there’s nothing much to worry about if your filings are accurate. Here are the steps you need to take to ensure you’re ready for any questions or scrutiny:
Step #1: Review the Audit Notice
The first thing you need to do is carefully read the audit notice sent by the IRS. It will specify the type of audit (correspondence, office, or field), the tax year under review, and the areas of your return they want to examine.
Knowing exactly what the IRS is asking for can be a plus. Additionally, never ignore the notice, as it can lead to penalties or additional complications.
| Verify the authenticity of the audit notice by cross-checking the contact details with the IRS website. Scammers often send fake IRS audit notices. |
Step #2: Organize Your Records
After reading the notice, you’ll see a list of documents requested by the IRS, such as receipts, invoices, bank statements, or canceled checks. Take your time to collect everything relevant to the specific items under review. It’s best to keep your records organized for easier access.
If some documents are missing, consider contacting banks, employers, or service providers to request duplicates. Well-organized records demonstrate your commitment to transparency and can help speed up the audit process.
| Keep a digital backup of all your tax-related documents to ensure you don’t lose important files. |
Step #3: Understand Your Rights
As a taxpayer, you have rights during an audit. Familiarize yourself with the IRS Taxpayer Bill of Rights, which includes the right to privacy, the right to representation, and the right to appeal. When you know and understand your rights, you won’t feel intimidated during the process.
If you’re unsure about any part of the audit or feel that the IRS’s requests are unreasonable, you can question their demands or seek clarification.
Step #4: Consult a Professional
An experienced tax professional, such as a CPA, enrolled agent, or tax attorney, can be invaluable during an audit. They know the ins and outs of IRS procedures and can guide you on how to present your case in the best way.
Professionals can also communicate with the IRS on your behalf, reducing the stress of direct interaction. Hiring a professional can be costly, but avoiding errors or penalties is often worth the investment.
You can also hire a bookkeeper for your business to avoid such audits completely.
| Choose a tax professional with audit experience to get the best results. |
Step #5: Prepare Explanations
Now that you’ve gathered all the necessary documents and details, be ready to explain any discrepancies or unusual items in your tax return. For instance, if you claimed a significant deduction for a charitable contribution, make sure you have the necessary documentation and a clear explanation of why you did it.
The IRS is primarily looking for accurate and honest answers. If you made a mistake, own up to them and provide corrective measures. The more you cooperate, the easier it will be for you to resolve the audit faster.
What Should You Expect During the IRS Tax Audit?
An IRS tax audit is more than just submitting documents. You can be asked about your financial activities beyond the tax year under review. This could include inquiries about past returns, significant purchases, or transitions that seem unusual.
Moreover, if you’re in an in-person audit, you’ll work directly with an IRS agent. Most agents maintain professionalism, but you should never let your guard down, as they might try to dig deeper if the answers are unclear or inconsistent.
For higher-income taxpayers or those claiming substantial deductions, the IRS may compare your reported income to your lifestyle. For example, if you report low income but claim expenses for luxury items or hefty charitable contributions, the IRS may investigate whether your reporting matches your financial state.
The only thing you should remember is that most audits are routine and not criminal investigations. The IRS is primarily focused on recovering owed taxes and ensuring compliance. However, intentional fraud or large-scale tax evasion cases could lead to further legal consequences.
Let SmoothBooks Handle Your Future IRS Tax Audits
An IRS tax audit can be challenging to process, but it isn’t something you should be afraid of. Many audits are triggered by simple errors like misreported income or incomplete records. However, you can avoid all these pitfalls with affordable bookkeeping services.
And you don’t even have to go anywhere.
At SmoothBooks, we offer expert virtual bookkeeping services to manage your financial records with precision. Our services save you time, eliminate stress, and keep you compliant with IRS regulations.
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