Jeff MacNelly, an award-winning political cartoonist, is said to have summed up the IRS audit process in a way all of us can understand: “The opera reminds me of my tax audit. It was in a language I didn’t understand. And it ended in tragedy.”
This quote reflects the average taxpayer’s mentality – an audit is not a good thing, it’s shrouded in all kinds of technical tax language and it never works out well for anyone.
As a result, we want to avoid audits at all costs. We file our returns and pray to the heavens that we don’t get a letter in the mail. Here’s the good news: Most average taxpayers (one W-2, no investments, and minimal deductions) don’t have to worry about audits.
We’ll get to that in a few moments, but, for now, we want to give you a general overview of what we’re going to cover in this article:
- What are the three types of audits?
- How does the IRS figure out who gets audited?
- What are the chances the average person gets audited?
- What should you always do if you’re audited?
- What should you never do if you’re audited?
Once we finish up each of these areas, we’ll give you our final thoughts on the matter and provide a few links to other helpful tax articles we’ve written.
Before we jump into the specifics of audits, though, let’s clear up what the word “audit” means. The word experts at Merriam-Webster define an audit as, “a formal examination of an organization’s or individual’s accounts or financial situation.”
Simple stuff. If you get audited, the IRS requests more information about or explanations of (formal examination) the tax returns filed by you (the organization or individual).
“Audit” can also mean “a methodical examination and review”, which is why you’ll hear the word pop up in all kinds of situations.
A website’s copy can be audited. Your fantasy football team can be audited. Pretty much anything can be audited, and it doesn’t have to be the IRS doing the auditing.
The Three Types of Audits: Correspondence, Office, and Field
Taxpayers here the word “audit” and assume it means IRS agents show up at your door, but that’s not the case.
The IRS conducts three types of audits, and each of them vary in seriousness and thoroughness. One is a letter in the mail. The other two? A little more in-depth.
IRS Correspondence Audits
These types of audits take place through the mail and over the phone. The IRS will send you a letter requesting documentation that supports something you said on your return.
So, if you said you donated half of your income to charity, the IRS may send you a correspondence audit asking for documentation of those donations. As you gather your documents and send them off, you can speak with the IRS over the phone regarding specifics.
Craig W. Smalley, an Enrolled Agent (IRS expert) with CWSEAPA Accounting and Financial Services, says correspondence audits are the most common because recent congressional cuts have reduced IRS manpower.
Time magazine’s Money section confirmed this fact in 2015 in an interview with IRS commissioner John A. Koskinen, who said “the IRS lost more than 2,200 revenue agents in 2010.”
IRS Office Audits
An office audit is where you have an appointment to speak with an IRS agent face-to-face in an IRS office. As you can imagine, these scenarios are considerably more stressful than correspondence audits.
Because of this, the tax experts we spoke with recommended your accountant should always accompany you to your office audit appointment.
“You or your representative will meet with the examiner at the IRS,” said Abby Eisenkraft, an EA and CEO of New York-based Choice Tax Solutions Inc. “You will be asked to substantiate items on your tax return that they noticed when you originally filed.”
In other words, if you miscalculate a home office deduction and you end up claiming that 50% of your home is your office and not 5%, you’ll probably be asked about how you arrived at that percentage.
Pro tip: This article is designed to help the average taxpayer understand the audit process. If you’ve purposely evaded taxes and you get an audit, it’s time to hire a tax lawyer.
IRS Field Audits
The third type of IRS audit is what’s called a “field audit”. In this scenario, the IRS agent comes to your world, in person, and observes. Why?
Say your tax return claims you earned $36,000 last year, but you live in a 3,000-square-foot loft downtown and drive a fleet of Tesla sedans. Doesn’t add up, right? Sending someone in person is the quickest way to know if your lifestyle matches your tax return.
This is what David W. Klasing, a CPA and tax attorney with the L.A.-based Tax Law of Offices of David W. Klasing, says is your “economic reality”. You might claim that you made $36,000, but the reality of your economic situation – the cars, the loft – says otherwise.
These audits tend to be extremely in-depth, says Larry Elkin, a CFP and CPA with Palisades Hudson Financial Group LLC.
“With field audits, the IRS or your state agency goes through your records with a fine-tooth comb,” Larry said. “The situation is far more complex.”
Field audits don’t just take place at your home, though. IRS agents may show up at your place of business or your accountant’s office.
How IRS Audits Conclude
Your audit, whether correspondence, office or field, will end one of three ways.
Either your tax return won’t change because you were able to prove the information was correct, your return will change and you agree to the changes, or the IRS tells you what changes need to take place but you disagree and don’t consent to the changes.
If you agree to the changes, you’ll work with the IRS to pay your outstanding balance. If you disagree, you can file an appeal, ask for mediation or request to speak with an IRS manager.
All this is scary stuff, right? Nobody in their right mind would want to sit down with an IRS agent in an IRS office and answer questions about specific deductions or income statements.
It would really help out to know how the IRS decides who gets audited, and that’s what we’ll cover next.
The IRS Uses a Couple of Methods to Determine Who Gets Audited
If you were head of the IRS and your job was to weed out shady returns from the millions of 1040s that come in each year, how would you do it?
In our super-techie times, it’s pretty simple. Build software that can look for inconsistencies or irregularities in a tax return, then score that return based on those inconsistencies and irregularities. The more shadiness, the higher the points.
Then, when tax season ends and all the returns are in, you audit the highest scores. That’s exactly how the IRS does it.
They’ve got a scoring system called the Discriminatory Income Function (DIF).
“The IRS’ DIF score measures the differentials in income and expenses for a taxpayer,” Craig Smalley said. “The thought is, the higher the DIF score, the odds of being audited increase.”
If IRS computers give a tax return a high DIF score, Abby Eisenkraft says the return goes to an IRS staffer for review.
“The return then goes to a human being, and if it is decided that the particular item or items should be looked at, a notice will go out,” Abby said.
Other ways the IRS figures out potential errors is, in the case of a freelancer, comparing your 1099s and your return to other freelancers. If what you’re claiming as incomes and deductions create a mix of numbers out of the ordinary, the risk for an audit goes up.
Several of the experts with whom we spoke said, every once in a while, the IRS will also do random audits on returns that didn’t raise any red flags.
How Likely Is It That You’ll Be Audited by the IRS?
We felt one of the crucial questions of the audit discussion is the matter of odds: What are the chances that the average taxpayer gets audited? Based on our research, the chances are pretty low.
In fact, the IRS revealed in their 2015 interview with Time that less than 1% of all tax returns were audited, with the majority of those audits coming from returns claiming more than $200,000.
Only 0.53% of returns in the $50K-74,999K income bracket, which includes the average income of an American household, were audited.
Craig Smalley told us that, unless you get randomly selected, a taxpayer filing a 1040-EZ shouldn’t be too concerned about getting audited.
Abby Eisenkraft, on the other hand, said even taxpayers who file normal returns but have charitable donation deductions, for example, could get audited if their deductions raise red flags with the IRS.
“You might have a situation where someone has very high charitable donations,” Abby said. “In some cases, it may be legitimate and can be fully substantiated; in other cases, someone was being greedy and unrealistic.”
And this is where the average person needs to be careful, Abby told us. Don’t think that your income level automatically exempts you from an audit.
“It’s not always the amount of income that brings on the audit,” she said. “It’s questionable deductions on a tax return.”
What You Should Always Do If the IRS Audits You
While the chances of getting audited are pretty low, it’s still good to know what you should do if you get a letter or phone call from the IRS.
“The first thing to do is breathe,” Abby Eisenkraft told us.
Getting notice of an audit isn’t the end of the world. Read through the letter to figure out exactly what the IRS wants.
It could be they want proof of the charitable donations you put on your tax return. If that’s the case, ask the organizations to which you donated to provide you a statement from the tax year in question.
In many cases, the solution will be simple.
We like how Selena Maranjian put it in her 2015 article for The Motley Fool:
“To worry less about being audited, remember this: If you’re not trying to pull a fast one over on Uncle Sam, even if you’re audited, it’s not likely to be a big deal. The IRS will probably send you a letter questioning some aspect of your return. If you made a mistake, you can fix it, perhaps having to pay a penalty or some interest. If not, you can just substantiate whatever claim they’re questioning by providing evidence.”
Travis Greaves, a partner at Washington D.C.-based Greaves | Wu, also told us the first rule of audits is to stay calm.
“Don’t panic,” he said. “The IRS may simply want you to substantiate a deduction or provide further proof of income.”
Talk to a Professional
Travis went on to say that it’s always a good idea to consult a tax professional if you get audited.
“It’s advisable to contact a tax attorney or an accountant with experience in audits to review your matter and determine the scope of the audit,” Travis said.
We heard this same advice from Randy Becker, co-founder of Washington-based Becker Retirement Group.
This may be your first time dealing with an audit, but your tax professional has probably seen his or her fair share of IRS cases.
“It’s good to have a professional team member because they may have gone through many audits with their clients and will know how to shorten the time span of the audit,” he said, “and be very efficient as to what the IRS is really honing in on.”
Answer What You’re Asked and Nothing More
If you have to speak with and IRS representative over the phone or in person during your audit, tax experts across the country have one common piece of advice: If you’re asked a question, answer it with as few words as possible.
“Keep it brief,” Randy Becker told us. “Auditors are trained to listen to everything you say. So, if you’re asked a yes or no question, keep it to a one-word answer, or, ‘I don’t know.’”
Brian Boerner, a CPA based in Wisconsin, said you never want to tell the IRS more than what they ask for.
“Provide only the information and records the IRS requested, and don’t volunteer information,” he said. “Answer only the questions asked.”
Things You Should Never Do During an IRS Audit
For every expert tip about what you should do during an audit, there’s an equally important bit of advice about what you shouldn’t do.
Don’t Flip Out on Your IRS Representative
First order of business, says Randy Becker: Don’t lose your cool.
“Remember that auditors have a very tough job because many people are angry they’re being audited so these IRS employees are used to people taking out their anger and aggression on them,” he said.
Abby Eisenkraft told us the exact same thing. Losing it in front of your IRS agent makes you just another angry taxpayer, but it also can hurt your case.
“Never curse at or threaten the auditor; try to keep emotion out of things,” she said.
Don’t Forge Documents or Logs
Deductions are all based on recordkeeping. Can you prove the miles you drove for work? Can you prove your sales-tax deduction? Can you prove all the costs associated with your work move?
As our experts have said earlier in this article, audits can be simple if you provide the right documents. However, that solution has a downside. The simplicity of providing documents can give you the devious urge to forge said documents.
John Miller, a CPA based in Georgia, talks about forged mileage logs and other deduction-based records in a 2010 video about audits.
Taxpayers who claim mileage they didn’t actually drive might be tempted to buy an organizer and write down miles in the midst of the audit process.
Unfortunately, Miller said, IRS agents are well-prepared in the art of sniffing out false information. They’ll lead you down lines of questioning that will bring up inconsistencies in your forged mileage log.
It’s not worth the effort to fabricate expense logs or use other people’s receipts to substantiate your business deductions; the IRS knows, John said.
On that note…
Forging mileage logs or expenses is something you have to do on your own time during the IRS audit process.
Lying outright during an interview is something that happens on the fly, and, just like forged transactions or logs, the IRS will figure out your inconsistencies.
“Lying to a federal agent is a crime in and of itself,” said Todd A. Spodek, managing partner at Spodek Law Group in New York.
This is a phrase you’ll hear over and over again from tax professionals who deal with IRS audits.
“Lying to an employee of the IRS is a criminal offense. If you think the IRS catches you in a lie, you may be charged and imprisoned,” Parent said. “If you think the IRS won’t discover you lied to them, you’re gambling your freedom.”
Our Conclusions About the IRS Audit Process
Hearing the words “IRS audit” is like being the captain of a warship and hearing gun blasts in the distance and the sounds of shells screaming toward your boat. Your first thought is, “I’m sunk”.
However, it doesn’t have to be like that. The inherent fear most American taxpayers have is, statistically speaking unfounded. Less than one percent of taxpayers undergo an IRS audit, and the majority of those earn more than $200,000 a year.
That doesn’t mean that you’re free and clear of the IRS’ watchful eye if you make $55,000. Experts say the best way to avoid an audit is to report all your earnings and provide accurate deductions.
If the IRS does audit you, it will come in the form of a letter, an in-person visit, or an appointment at an IRS office.
Never lie, never give more information than you have to and be respectful. If you’re worried you might not know what to say during an IRS audit interview, hire a tax professional to go with you to a meeting.
The key is to answer all questions truthfully and with as few words as possible. If you’ve made a mistake on your return, Larry Elkins said, own up to it.
“Owning up builds credibility and shows the agent that you are making a good-faith effort to comply with the law,” Larry said. “That credibility might earn you the benefit of the doubt on other issues.”
As intimidating as they might be, audits are just one aspect of taxes and, percentage-wise, a relatively improbable on at that.
Make this year’s filing season a more efficient process by reading through our series of guides on taxes. We’ll help you understand which deductions taxpayers often miss and the common mistakes you’ll find on tax returns.
Those two articles alone can help clear up a lot of confusion. If you’re a freelancer, however, your tax situation is a little more complex.
That’s why we suggest reading our guide to freelancer taxes. We spoke with experts to get accurate advice about how to do your taxes like a pro.
And, finally, if you discover that you owe taxes this year, we’ll help you through the process of setting up a payment plan with the IRS.