Magnifying glass looking over the 1040 form, insinuating a tax audit

How Do Tax Audits Work?

May 16, 2023

Tax audits can be stressful, especially if you aren't prepared for how tax audits work. Fortunately, there are many ways to prepare in case of an IRS tax audit.

An audit can apply to many situations, not just tax related. A similar word for "audit" could be "examination." An audit is a type of formal examination or report. Often audits have to do with finances, like taxes. If someone is auditing something, they are looking closely into it, so when the IRS decides to perform an audit on your taxes, they are going to be looking more closely at your tax returns.

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What is an Income Tax Audit? 

income tax audit definition

An income tax audit is when the IRS decides to overview your tax return. This can sometimes include auditing (or examining) your tax returns for the past 3 years. The IRS's statute of limitation for tax audits is 3 years. In simple terms, an income tax audit is when the IRS notices something amiss with your tax return, and contacts you to try and fix whatever is wrong. Often this will include a closer look at your tax return and a report on anything they found that might need fixing. There are essentially 3 different kinds of tax audits to be aware of: a correspondence audit, a field audit, and an office audit. 

What is a Correspondence Audit?

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A correspondence audit is when the IRS sends you a correspondence (a letter) through the mail to perform the audit. 

A correspondence audit is for the most common problems that could occur with a tax return. They are for common mistakes and easier fixes. Often something simple is wrong with your tax return and the IRS just needs a little more information from you to fix it. You might have forgotten to submit a form, your handwriting could be hard to read, or there could be math errors that aren't adding up. 

The IRS will send you a letter with a request for additional information to fix your tax return. Send the letter back with whatever they have requested, and they will amend your tax return to be correct. They might need additional information, clarification about something, or a missing document. They might request: 

  • home mortgage statements
  • tax returns
  • receipts
  • brokerage statements
  • retirement account records
  • pay stubs

What is a Field Audit?

field audit graphic

A field audit is when an IRS representative visits your home or business to perform the audit. 

A field audit is for when an IRS examiner needs to verify information on your tax return that might have raised some red flags and requires some physical looking into. Maybe you are trying to claim dependents that someone else also tried to claim, or maybe you tried to take a big tax deduction, claim a tax exemption, or write off for your business that seems a bit larger than normal. 

The IRS will send an IRS Revenue Agent to your home or business to perform the audit. Once there, this agent will review financial records, bank statements, receipts, and even speak with employees and tour the facilities when businesses are involved. This visit will hopefully clarify any confusion, discrepancy, or missing information in you or your business's tax return. 

What is an Office Audit? 

office audit graphic

An office audit is when you visit an IRS office to meet with an IRS examiner to perform the audit. 

An office audit is for when more items from the audit report need to be discussed then can be discussed in a field visit or correspondence letter. The audited parties, usually a business, will have an appointment to meet with an IRS examiner in an IRS office. Here all the parties involved will be able to go through the audit examination and report. You, any applicable business associates, tax preparers, accountants, or lawyers may also be present for this appointment. 

The Tax Audit Process

The tax auditing process will look different depending on who is being audited and the items in question on the report. For instance, an individual taxpayer will most often have a simpler and quicker auditing process than a business organization. But the process will generally look the same. The IRS will contact those involved about the audit, and official examination and report will be overviewed by the parties involved, and the audited parties will have the chance to correct any errors, pay any missing taxes, and move on. 

Step 1: The IRS Audits Your Taxes and Sends a Report

Whether you get a simple letter asking for a missing 1099 form, or if you get an appointment set up to visit an IRS office, the IRS will perform their audit and create a report. This process might involve you providing additional information or clarifications.

Once the audit is finished, the IRS will send you a report detailing the audit and what they found. This report might let you know you have unpaid taxes that need paid now, or it might simply correct something on your tax return from this year. 

Step 2: The IRS Sends a 30-Day Letter 

30 vs 90 day letter graphic

When your audit is over, you'll be given a letter that is called the 30-Day Letter. This letter has a copy of the examination report and an explanation of what the IRS found in their audit. This could include things that need to be fixed on a tax return or taxes that still need paid. 

The letter will also include information about how you have a right to appeal any items on the audit if something they found is not correct. This tax audit appeal information will come in a document attached to the letter called, "Your Appeal Rights and How to Prepare a Protest If You Don't Agree."

This letter is called the 30-Day Letter because you have 30 days to respond to the letter. You should consult with a tax filing professional, or your lawyer when applicable, to help you go over the report thoroughly before you respond to the 30-Day Letter. Once you are ready to respond you can appeal if you found something to be incorrect, or sign and agree to the changes and send that agreement back to the IRS before the 30 days are up. 

Step 3: The IRS Sends a 90-Day Letter

90 day letter vs tax court graphic

If you appealed the 30-Day Letter, then the next step will include the IRS sending you a 90-Day Letter. This is like the IRS's response letter to your appeal of the items noted in the 30-Day Letter. After you get the 90-Day Letter you'll then have 90 days to review the report and either agree with the new audit report or appeal your tax audit further in Tax Court. 

If you do need to escalate to Tax Court, you need to be 100% certain that you are correct and that the examiner's findings are wrong. 

Another important thing to remember in appealing tax audits from the IRS is that if part of your audit includes unpaid taxes that the report is saying you still owe, interest will accumulate on those unpaid taxes, causing the amount you owe to grow for as long as that amount goes unpaid.

How to Avoid a Tax Audit

how to avoid a tax audit graphic
  • Keep detailed financial records for up to 3 years. Three years is the standard statute of limitations for the IRS to audit tax returns so long as those tax returns were filed on time. 
  • File your tax returns on time each year. The 3-year statute of limitations doesn’t apply when your tax returns were filed late, so avoid longer tax audits by always filing on time. 
  • Explain anything you want to itemize on your return. If you want to include something as a business expense, include an explanation from the beginning. 
  • Don't take out more deductions than you qualify for. Claiming tax deductions and tax credits can seem like a great idea, but if it's questionable whether the deduction or credit really applies to you, it might be smarter to not bother. 
  • Use a tax professional. Tax filing software can make tax filing so much easier but having an actual tax professional go over your taxes will decrease the amount of errors or missing items. 
  • File electronically. Don't get audited due to bad handwriting and file electronically instead of paper filing. If technology is not your thing, you can provide copies of the necessary documentation to a tax professional, and they file electronically for you!

In Conclusion,

Tax audits aren't fun, but they also are no need to panic. Prepare now for potential audits in the future and then you can rest easy knowing you've got yourself covered. Use professional tax filing services too, and you can get the extra care and double checking you need to make sure everything is just right.