What does it mean to get audited by the IRS?
Getting audited means the Internal Revenue Service (IRS) is going to take a closer look at your tax return to make sure everything is accurate. There are a few different kinds of audits the IRS may conduct:
– Mail audits – The IRS sends you a letter requesting documentation to support certain items on your return. This is the most common kind of audit.
– In-person audits – An IRS agent will meet with you to go through your records in more detail. This is more intensive than a mail audit.
– Field audits – An IRS agent visits your home or office to verify assets and documentation. This is reserved for more complex returns.
So in short, an audit means the IRS has questions or concerns about your tax return and wants to verify the information. It does not necessarily mean you are in trouble or did something wrong. Many audits are routine and do not result in any changes.
What triggers an IRS audit?
There are a few red flags that may increase your chances of being audited:
– High income – Returns reporting income over $200,000 are more likely to be examined.
– Unreported income – The IRS is very focused on finding unreported income. Audits often occur when your income doesn’t match up with Forms W-2 and 1099.
– Suspicious deductions – Claiming excessive charitable donations, business expenses or casualty losses can raise eyebrows.
– Math errors – Simple math mistakes may get your return flagged for review.
– Previous audits – If you’ve been audited before, you’re more likely to be audited again.
– Occupation – Some occupations, like small business owners and the self-employed, see more audits.
– Amended returns – Filing an amended return correcting mistakes from an original return can prompt an audit.
– Virtual currency – Reporting virtual currency transactions has become an audit trigger.
So while getting audited does not mean you’re necessarily in trouble, certain items on your return may increase audit risk. Reporting accurately and having documentation is key.
What happens during an IRS audit?
The audit process typically goes like this:
1. You’ll receive a letter from the IRS explaining they will be auditing your return. The letter provides information on what documentation you should gather and send in response.
2. Assemble the requested documentation and provide it to the IRS by the deadline in the letter. Work through your CPA or tax preparer if you used one.
3. For mail audits, the IRS will review your response and documentation and let you know the outcome. Usually they accept the information and close the audit.
4. For in-person audits, after you provide information, you’ll attend an interview with an IRS agent. They can request additional documentation during this meeting.
5. After the interview, the IRS will follow up with the results. Often they make no changes, but they may dispute certain items and propose additional tax, interest and penalties.
6. If you disagree with the IRS findings, you can provide additional documentation and appeal. The appeals process can be lengthy, but allows you to make your case.
7. Once the audit is closed, you will receive a closing letter and summary report indicating any changes to your tax liability. Pay any additional amounts owed.
The key is being organized, responsive and cooperating fully during the audit. Work closely with your tax professional and carefully follow audit protocols.
What documents do I need for an IRS audit?
If you are being audited, having the right documentation on hand can help the process go smoothly and resolve the audit quicker. Here are some of the most important documents to have ready:
– Copies of the tax returns being audited – Both your original return and any amendments are crucial.
– Supporting tax forms – W-2s, 1099s, 1098s and any other forms backing up the income, deductions and credits on your return.
– Bank and investment account records – Statements and documentation verifying income and deductions claimed.
– Receipts for deductions – Itemized deduction records like medical bills, charitable donations and business expenses.
– Business records – Ledgers, inventory logs, business mileage logs and other documents if you report business income or loss.
– Proof of virtual currency transactions – Records showing dates, amounts and purpose of any virtual currency trades.
– Real estate records – Closing documents, purchase and sale agreements, property tax invoices and improvement receipts if you own property.
– Vehicle records – Purchase/lease contracts, financing agreements and mileage logs if you claim auto expenses.
– Legal documentation – Contracts, lawsuits, judgments or anything else relevant if you claim certain legal deductions.
Having your accounting books and supporting documents organized makes the audit process faster. Work closely with your tax preparer or CPA as well to obtain needed documents.
If I made a mistake on my taxes, how much trouble am I in?
Even if you made errors or omitted information on your tax return, you may not necessarily be in major trouble depending on the circumstances:
– Minor mistakes – Simple math errors or leaving off small amounts of income may just result in paying back taxes and interest. Penalties are unlikely.
– Unreported income under $5000 – You may face an accuracy penalty of 20% of the unreported amount, but jail time is very unlikely.
– Unreported income over $5000 – More serious penalties and criminal prosecution are possible if large amounts of income were intentionally not reported.
– Frivolous tax positions – Taking positions like claiming the income tax itself is unconstitutional can lead to a penalty of up to $5000.
– Tax fraud – Willfully evading taxes or filing a false return can mean up to 5 years in prison and owing the IRS 300% of the tax owed.
– Failure to file – Not filing a return when required can result in penalties of 5% per month of the unpaid tax up to 25% in total. No jail time but interest accrues.
– Failure to pay – Not paying taxes owed by the deadline can lead to penalties of 0.5% per month of the unpaid tax up to 25% in total. Interest charges still apply as well.
The key takeaways are minor mistakes generally just mean paying back taxes and interest, but purposefully underreporting income or committing tax fraud leads to much stiffer criminal penalties. Be upfront about any mistakes to mitigate penalties.
What should I do if I discover an error after filing my taxes?
If you discover you made a mistake on your already filed tax return, here are some options:
– File an amended return – Use Form 1040X to correct your original return. Pay any additional tax owed. Amended returns must typically be filed within 3 years.
– Write the IRS explaining the error – If you owe no additional tax and already received your refund, writing the IRS with an explanation may suffice.
– Do nothing – For small errors under $5000 resulting in little tax impact, doing nothing is sometimes an option, but risks an audit.
– Pre-emptive voluntary disclosure – For unreported income errors, consider making a voluntary disclosure to the IRS before you are audited. This shows good faith.
– Request penalty relief – For certain errors like late filing or payment, you can request penalty abatement by showing reasonable cause. Use Form 843.
– Pay immediately – If you owe additional tax, pay as soon as possible to minimize interest charges and late payment penalties.
– Consult a tax professional – Discuss the situation with a CPA or tax attorney to understand your options and risks. Getting expert help is wise.
Discovering a tax return error can happen to anyone. Being proactive in addressing it reduces your risk and penalty exposure. The IRS looks favorably on taxpayers who make efforts to comply.
When does the IRS charge fraud penalties?
The IRS charges fraud penalties when they can establish the taxpayer intentionally tried to evade taxes. Some key indicators of tax fraud include:
– Dramatically underreporting income – Omitting amounts of income over 25% of the reported total often raises red flags of fraud.
– Using false Social Security numbers – Inventing fake Social Security numbers to claim false dependents or credits suggests willful tax evasion.
– Claiming false deductions – Fabricating deductions for expenses never incurred points to fraudulent intent.
– Hidden income sources – Failing to report income from secret accounts, businesses or assets indicates fraud.
– Fake businesses – Creating sham businesses just to claim false losses is fraudulent.
– False amended returns – Filing an amendment just to claim fake refundable credits implies fraud.
– Frivolous tax arguments – Taking an unreasonable position that tax laws don’t apply to you demonstrates fraud.
– Destroying records – Shredding documents when you know you are being audited obstructed the IRS, suggesting fraud.
– Criminal tax violations – Actions like tax evasion, filing false returns and identity theft mean automatic fraud penalties.
– Repeat offenses – Commiting tax fraud more than once makes fraud penalties more likely and more severe.
The civil fraud penalty is 75% of the unpaid tax owed. Criminal fraud can result in fines up to $100,000 and imprisonment up to 5 years. The IRS does not pursue fraud penalties lightly, but the consequences are severe.
Can I negotiate with the IRS during an audit?
Yes, it is often possible to negotiate with the IRS during an audit, within reason. Some scenarios where negotiations occur include:
– Unreported income – You may argue the unreported income was an oversight and negotiate a smaller penalty.
– Fixing honest mistakes – The IRS may accept removing penalties if you can demonstrate the audit findings were honest mistakes.
– Penalty abatement – You may request penalty relief for things like late filing if you have reasonable cause.
– Payment plans – The IRS may negotiate a payment plan if you cannot pay in full immediately. This still includes interest and some penalties.
– Settlement offers – For more complex audits, you can propose a settlement for a lesser tax liability than proposed by IRS.
– Proving a deduction – You may be able to negotiate allowance of a disputed deduction by providing more persuasive documentation.
– Correcting clerical errors – Simple errors in things like names, addresses or SSNs can be quickly negotiated.
– Audits lasting over a year – If the audit dragged on too long, penalties for late payment during that time may be negotiated.
The keys are having a reasoned basis for negotiating, maintaining thorough documentation, staying calm and presenting facts in a compelling manner. Negotiating with the IRS is the exception rather than the rule, however.
Should I amend past returns if I discover errors?
If you uncover errors on tax returns from prior years, amending can make sense in some cases:
– If you are owed a refund – Amend to claim a refund within 3 years of the return’s due date. Otherwise the money is forfeited.
– To minimize penalties – Amending shows good faith and can reduce penalties on underreported taxes.
– When you underreported income – Amending to correct unreported income reduces penalties and can avoid criminal prosecution for tax evasion if done before audit.
– For sizable errors – Amending makes sense for large errors that significantly impact the amount of tax owed.
– To take advantage of deductions – If you missed deducting large expenses from older returns, amending can recover some tax paid.
– When your situation changed – Events like divorce decree alterations and business audit findings may necessitate amending.
Amending does not make sense in some cases:
– Minor errors – For small mistakes resulting in little tax impact, amending may not be worthwhile.
– Charitable deductions – Cannot be amended to increase deductions except in special disaster circumstance.
– Correcting clerical errors – The IRS can fix minor clerical errors without amending the return.
– When audit risk increases – Amending some older returns may just increase your audit risk.
– When statute expires soon – If the statute will expire soon, no need to amend just as it becomes unavailable.
Talk to your CPA or tax professional to assess if amending an old return is advantageous or not based on your specific tax situation.
How many years of tax returns can the IRS audit?
The IRS can generally audit tax returns going back three years from the date the return was filed. Some key details on how many years can be audited:
– Three year statute – The IRS typically goes back three tax years for audits. For example, in 2022 returns for 2019, 2020 and 2021 could be audited. Returns before 2019 would be expired.
– Six year statute – The statute extends to six years for substantial underreporting of income over 25% of the amount reported.
– No limit on fraud – If tax fraud or evasion is discovered, the IRS can audit returns beyond 6 years with no limitations.
– Three years after amendment – Amended returns create new statutes of limitation. The IRS has three years from the amendment filing date.
– Six years after omissions – If a return omits more than 25% of gross income, the IRS has 6 years to audit after it is filed.
– No limit on non-filers – If no return was filed, the statute never runs out and the IRS can audit forever.
So while the typical audit looks at three years, intentionally underreporting income or committing fraud opens the door to much older returns coming under IRS scrutiny with no limitations.
Should I extend my tax return if I suspect problems?
Deliberately extending your tax return filing due date is generally not recommended if you suspect your return may have issues:
– Penalties can worsen – Extensions give you more time to file but not to pay. Penalties for late payment continue building.
– Interest charges accrue – Interest accrues on any unpaid tax during the extension, increasing the amount owed.
– Problems won’t disappear – More time does not make tax problems go away. It delays resolving issues.
– May increase audit risk – Extensions raise red flags and can increase audit risk in some cases.
– Opportunity to correct – If amending prior to audit, it’s better to be proactive and correct promptly. Extending delays this.
– Reduces time to appeal – If audited, extending cuts the time you have to dispute audit findings through appeals.
– Delayed refunds – Extending delays receiving any expected tax refund until the return is finally filed.
In some cases extensions make sense, like needing more time to assemble complex supporting documents. But in most cases it is better to file on time – or early – and correct any mistakes known before filing. Avoiding an extension minimizes penalties and interest and gives the IRS fewer reasons to notice your return.
Conclusion
Getting audited by the IRS can feel scary and stressful for many taxpayers. However, the reality is most audits are routine and focus on verifying details on your returns. Having organized documentation can facilitate the process. Intentional evasion or fraud is what leads to more serious penalties and prosecution.
For ordinary taxpayers who try to file accurate returns, getting audited does not inherently mean you are in trouble even if some mistakes are uncovered. Being responsive to IRS inquiries and working diligently to resolve discrepancies in your returns can keep routine audits from becoming problematic. Maintaining meticulous tax records is always wise to avoid issues if audited. With the right documentation and representation, getting audited does not have to be an intimidating process even if some anxious moments arise.