By Mauro P. Colabianchi
With the filing season for 2017 tax returns behind us, a taxpayer’s thoughts may turn to…audits. The IRS will start to flag returns for irregularities. Those who receive audit notices would do well to respond timely.
How Does the IRS Decide to Audit a Specific Taxpayer?
In 2016 the IRS audited approximately 0.5% of all returns filed, owing in part to Service’s limited resources. Most returns by far are accepted by the IRS without change. Given these numbers, the IRS audit selection process is designed to target taxpayers whose returns are most likely to be incorrect, and where an audit would result in more revenue to the government.
The IRS has three principal methods to select a taxpayer for audit.
- Income Document Matching Program. The simplest method, the IRS computer system will match a taxpayer’s return with income documents such as W-2s and 1099s. If these income documents received from third-parties do not match the information on your tax return, you may be audited.
- Random Selection and Computer Screening. The IRS uses a computer scoring system that assigns a numeric score to each item on a tax return based on how that tax return compares to other similar returns. The higher the score, the greater the likelihood of your tax return being selected for audit.
- Related Examinations. If, for example, a business partner of yours is audited and there are items that involve shared transactions or issues, then the IRS may also select your return for audit.
Where Will the Audit Take Place?
In 2016, 71% of all audits were audits by mail. The IRS will send a letter requesting additional information and the taxpayer will need to send in their supporting documentation. If the audit involves more complex issues, then the audit may take the form of an in-person interview, either at the local IRS office (usually for returns with a small number of issues) or at the taxpayer’s home or office (usually for returns with many issues being audited where the tax records may be extensive).
What to Expect
The audit begins when you are notified that your return has been selected for audit. The IRS will provide a written list of documents the auditor will want to see. After review of the supporting documentation, any proposed changes to your return will be explained to you or your representative. Be courteous and organized, but also be prepared to defend the position taken on your tax return. At the end of the audit, a report will be issued with any changes to the tax return proposed by the IRS.
The Right to Appeal
If you agree with the changes to your tax return, then sign the audit report and pay any additional taxes. If you do not agree, then you may talk to the auditor’s supervisor (for in-person audits). You may also file an appeal to the IRS Office of Appeals. You generally have 30 days from the issuance of the audit report to file an appeal. If you ignore the 30-day timeframe, the IRS will issue a Notice of Deficiency, giving you 90 days to file a petition with the Tax Court to dispute the proposed tax increase. If the Notice of Deficiency is ignored, the new tax liability becomes final.
IRS audits can occur for several reasons and in many cases can become an adversarial process. Taxpayers should keep good records to back up the numbers on their return and be aware of their legal rights during the audit process. Seeking qualified legal counsel for this purpose can make all the difference.
About the author: Mauro Colabianchi, JD, LL.M, is an attorney with McLaughlin Legal, who represents businesses and individuals in all aspects of Federal and California tax law, with an emphasis on representing taxpayers in civil and criminal tax litigation and controversy cases. Reach him at firstname.lastname@example.org.