If you’ve helped an individual or business client prepare for an audit, then you probably have played the roles of friend, nursemaid and psychiatrist, but more than anything else, you’ve used your knowledge of tax and the IRS to ensure your client understands many of the somewhat-complicated components associated with an audit.
Whether you have this experience or have yet to navigate the audit process for a client, here’s a primer on how audits are conducted the IRS:
An IRS audit is a review or an examination of a taxpayer’s accounts and financial information, in order to verify that information is properly being reported, tax laws are being followed and the amount of tax reported is substantially accurate.
Tax returns are selected for audit by the IRS using the following three methods (an audit does not necessarily suggest an error has been made):
- Random selection and computer screening: sometimes, returns are selected based solely on a statistical formula.
- Document matching: occurs when payer records, such as Forms W-2 or Form 1099, do not match the information reported.
- Related examinations: returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.
An audit may be conducted by mail, or through an in-person interview and review of the taxpayer’s records. The interview may either take place at an IRS office (office audit), or the taxpayer’s home, place of business or accountant’s office (field audit). The IRS will notify you about an audit by mail or telephone, and will indicate the records that are needed. A letter from the IRS will follow a telephone contact, and the IRS does not notify via email.
Taxpayer’s rights during an audit include the following:
- A right to professional and courteous treatment by IRS employees.
- A right to privacy and confidentiality about tax matters.
- A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.
- A right to representation, by oneself or an authorized representative.
- A right to appeal disagreements, both within the IRS and before the courts.
- The right to pay no more than the correct amount of tax.
An audit can be determined, and concluded, in the following three ways:
- No change: taxpayer has substantiated all items being reviewed.
- Agreed: taxpayer understands and agrees to the changes proposed by the IRS.
- Disagreed: taxpayer understands and disagrees to the changes proposed by the IRS: A conference with a manager may be requested for further review, and Appeals Mediation Programs are available, or an Appeal request may be filed.
Here is a diagram from the IRS that illustrates the audit process:
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- Publication 556, Examination of Returns, Appeal Rights and Claims for Refund explains the audit process in more detail
- Publication 1, Your Rights as a Taxpayer, explains your rights as a taxpayer, as well as the examination, appeal, collection and refund processes
- Publication 3498-A, The Examination Process (Audits by Mail)
Editor’s note: For more information, check out other articles in Mike D’Avolio’s series on audits.