An audit is an examination of the financial information reported on a tax return to determine whether that information is correct according to current tax law. You have the burden of proof to substantiate the deductions claimed on their tax return. A tax audit is usually initiated with a letter. You then have a specified number of days to provide the appropriate documentation and/or appeal. You can expect the audit to be conducted by mail or in person.
Why is the IRS Auditing Me?
Many people wonder what causes an audit. The simple answer is there could be a variety of reasons why your tax return could be selected for an audit. Some targets include:
- High income earners
- Income reported to the government but not reported on your tax return
- Operating in a high-risk business (such as mostly cash business)
- Business you are involved with is under audit
- Whistleblower alerted authorities that you are an audit target
- You claim large expenses relative to your income
Can You Go To Jail For An IRS Audit?
We are often asked if the IRS will send you to jail if they audit your tax return and find something that needs to be corrected. Well that’s not how it typically works. The purpose of the audit is to ensure that the government collects what they believe is rightly owed them. Most times if you provide the requested documentation and state your case effectively the matter can be resolved.
What To Do When Being Audited
So what should you do when you receive a notice that you are being audited. First things first, don’t panic! Gather documents and receipts for the deductions that you have claimed. Many times your case can be remedied without as much pain as you think.
The IRS has a certain amount of time, called the statute of limitations, to assess tax for a given year. Generally this is 3 years from the date the tax return is filed or the due date of the tax return, whichever is later. In other cases such as when 25 percent or more of your income is underreported, they have 6 years to assess the tax. When no tax return is filed, or when fraud is involved, there is no statute of limitations.
Don’t ignore the letter you received. Many IRS letters are time-sensitive and failing to respond to them in the allowable time frame can forfeit your appeal options. They say that the only things that go away if you ignore them are your teeth and that holds true with audits. Tossing a letter in a desk drawer and burying your head in the sand will not make the problem go away. Don’t just accept what’s on the notice as set in stone. Sometimes the IRS is sometimes wrong. However, it is up to you to prove that they are.
If the audit results in an underpayment expect to be hit with penalties. Many people are familiar with the failure-to-file and failure-to-pay penalties, both of which can be assessed if submissions are not made by the due date. It may come as a surprise that the IRS can slap you with accuracy and civil fraud penalties as well.
An accuracy-related penalty equal to 20% of the underpayment is doled out when the taxpayer disregards the tax law and substantially understates their income or fails to keep adequate records. Regular bookkeeping is important to running a business but it can really come back to haunt you if an accuracy-related penalty is added to your tax due.
A civil fraud penalty is assessed when the tax return was filed but there is clear and convincing evidence that there was some fraud involved. The civil fraud penalty of 75% of the underpaid tax. If there is fraud involved, or the IRS suspects fraud, then it would be wise to contact a tax attorney immediately.