Tax Audits

Key Takeaways:

• Purpose of audits: IRS audits check tax compliance.
• Audit Process: Audits can be done by mail, in-office, or on-site.
• Audit Challenges: Missing records or inaccurately filed returns.
• Timelines: Audits typically go back three years, but significant income understatements or fraud can increase time limits. 
• Failing an audit: Penalties apply, but resolution options exist.

Common Triggers for Audits

When the IRS and/or NYS Department of Taxation and Finance (DTF) begin an audit, it is not something to take lightly. While some returns are randomly selected for an audit, others are earmarked for audits based on specific criteria. 

IRS audits can be triggered by various factors. These red flags can prompt the IRS to take a closer look at a taxpayer’s return.

Common reasons for audits include:

• The income reported on tax returns doesn’t match the income reported to the IRS and NYS governments, 
• The IRS or NYS computer systems picked up anomalies in returns (e.g., reporting unusually high itemized deductions, claiming unreasonably high business mileage expenses, etc.), 
• The reported gross sales on sales tax returns don’t match gross sales reported on business income tax returns, 
• The return appears to have abusive claims for refundable tax credits such as the Earned Income Credit (EIC),
• There are also reverse audits which occur when information found in audits of one taxpayer causes an audit of another taxpayer. 
• Whistleblower audits – when someone “blows the whistle” on another taxpayer by reporting them to the IRS and/or NYS DTF.

Types of Tax Audits

The audit process can take several forms:

• Correspondence audits occur via mail, focusing on specific issues.
• Office audits require the taxpayer to visit an IRS office.
• Field audits involve IRS agents visiting the taxpayer’s home or business.

In all cases, you will be contacted by the auditor initially through the mail. The notice will explain which type of audit you’re facing, and it will outline the next steps. 

Each of these types of audits can focus on different elements. For instance, the IRS or the state may audit your entire business or individual return, or they may just ask you to verify some of the information in these returns. New York State, in particular, does a lot of residency audits where they check the state residency status of taxpayers who filed as non-residents or part-year residents. 

What Happens in an IRS Tax Audit?

At its core, an audit is relatively simple – the IRS simply asks you to back up information reported on your tax return. 

For instance, if you claimed a dependent for the purposes of getting the Earned Income Tax Credit, the IRS may ask for birth certificates, custody agreements, or other details proving that you have the right to claim that person as a dependent. If the IRS is auditing your business return, you will need to provide sales records, receipts, invoices, and other documents to back up the income and expenses reported on your business return. 

When the IRS first contacts you, they will send a list of the items they want to see. With a correspondence audit, you can simply mail in documents. However, if you’re dealing with a business return or a complicated individual return, you may need to meet in person and allow the IRS to look through your records. After the IRS reviews the documents, they may ask for more information. 

Based on the information received, the IRS auditor will decide whether to accept your return as filed and make changes based on the information provided. At that point, you can appeal their results or accept the changes. Then, depending on the situation, the IRS may assess penalties, and the agency will apply interest to the tax due, backdated to the original due date. Finally, you must pay any additional tax assessments and penalties. If you cannot pay in full, there are a variety of payment options for unpaid taxes. 

Audit Information Document Request (IDR) & Form 4564

During an audit, the IRS may issue an IDR or Form 4564, requesting detailed records. Responding thoroughly and promptly is essential. Properly gathering, organizing, and presenting documentation can meet IRS requirements effectively, reducing the risk of adverse outcomes.

IRS Audit Letters and Summons

Receiving an audit letter or summons can be alarming. Both of these communications outline the IRS’s concerns and the scope of the audit. The audit process starts with an audit letter, and you may receive additional letters or notices throughout the process. Finally, at the end of the audit, you’ll receive a determination letter with the results of the audit and instructions on how to appeal if you disagree. 

The IRS may also summons information from you or other parties. For example, if you don’t provide the requested documents, the IRS may send a summons to your bank, crypto exchange, investment company, clients, vendors, or anyone else who may have the information the IRS wants to see. If a summons is issued, the audit may escalate, potentially leading to more intensive scrutiny. Timely, accurate responses help mitigate risks.

What If You’ve Been Audited and Don’t Have Receipts?

Missing documentation complicates audits, but it’s not necessarily a dead end. If you don’t have receipts for your deductions or charitable contributions, the IRS may accept reconstructed records or alternative forms of evidence. Rebuilding records and presenting credible substitutes for missing receipts can make a substantial difference in getting through an audit successfully.

Substance Over Form: Key Principle in Audits

The IRS often prioritizes the substance of transactions over their formal appearance. This principle means that the intent behind financial activities can carry more weight than the paperwork. Clarifying and justifying tax positions to auditors can focus on substantive compliance.

Audit Statute of Limitations

Generally, the IRS can audit returns filed within the past three years, though this extends to six years for significant underreporting of income or tax liability. In cases of fraud or unfiled returns, there may be no statute of limitations. Understanding these timeframes is crucial for tax planning and audit defense.

What Happens if You Fail an IRS Audit?

Failing an audit can lead to penalties, including accuracy-related fines, civil fraud penalties, and interest on unpaid taxes. For those unable to pay, options like payment plans or Offers in Compromise exist. Exploring all available avenues can help manage or reduce financial liabilities.

Tax Audit Reconsideration

Taxpayers disagreeing with audit results can request reconsideration, especially if new evidence emerges or IRS errors are identified. Filing reconsideration requests with compelling arguments can challenge unjust audit findings. Make sure you request reconsideration by the deadline. 

Chances and Risks of Being Audited

While audit rates are relatively low, certain factors, like high-income levels or complex deductions, increase audit risk. Proactive measures like meticulous record-keeping and strategic tax planning can help minimize these risks and help prepare for a possible audit.

How to Survive a Tax Audit

Key survival strategies include staying organized, responding promptly, and maintaining respectful communication with IRS agents. Most importantly, seeking professional assistance can turn a stressful audit into a manageable process.

Why Choose McLaud Law for Tax Audits?

McLaud Law P.C.’s expertise in tax audits, personalized strategies, and commitment to client advocacy set the firm apart. With a track record of favorable outcomes, our team of tax resolution professionals provides invaluable support through every stage of an audit.

High-quality audit representation requires more than just being knowledgeable about the Internal Revenue Code, NYS Tax Law, and regulations. It takes years of experience, specialized legal training, and advanced knowledge of the audit process, appeals process, and court remedies. McLaud Law P.C. offers a free initial consultation, so if you receive an audit notice, there is no reason not to call us to find out how we might be able to help with your tax problem. 

If you’re facing an audit or want to fortify your tax practices, McLaud Law P.C. is ready to help. Schedule a consultation today to gain a trusted partner in navigating IRS audits and safeguarding your financial future.

Contact McLaud Law to learn more and take control of your tax situation with confidence.