Introduction
IRS audits occur for many reasons, such as mismatched documents, high business expenses and charity contributions, tax irregularities, or potential tax fraud. The Internal Revenue Service (IRS) also audits based on specific industries and geographical locations.
However, you may have questions regarding what an IRS audit is, who performs it, what are the types of IRS audits are, and exactly what to do when an IRS audit occurs.
Therefore, in this blog, we have provided the IRS Audit Guide for 2024 and discussed everything you need to know and do when you get notified for the IRS audit.
Let’s begin!
What is the IRS audit?
An IRS audit is an evaluation of an individual or organization's tax return to ensure that the information provided is accurate and comprehensive. It happens for many reasons, such as suspected underreporting of income, incorrect deductions, or failure to file a return.
Who does the IRS audit?
In a recently released news, the IRS has reported that it has exceeded $1 billion in tax collections from higher-income taxpayers who have fallen behind on their payments, because of its continued compliance initiatives under the Inflation Reduction Act.
The IRS has taken targeted action against 1,600 individuals whose annual incomes exceed $1 million and who each owe more than $250,000 in estimated tax liabilities. This group has collectively contributed over $1 billion more than the previous one because of the IRS's efforts.
Indeed, the IRS receives third-party information from sources such as Forms W-2 and 1099, indicating that these individuals earned income within certain ranges but failed to file a tax return.
Then, the IRS tracks them by sending audit letters and proceeding with the audit. Before going through the IRS audit process, let's first understand the types of IRS audits.
Types of IRS Audit
1. Mail Audit
Regardless of the audit type the IRS chooses to perform, you will receive notification by mail. A mail audit does not involve an in-person meeting with an auditor and refers to the IRS asking for more details to confirm records from your tax return.
For instance, if you claim $20,000 in charitable deductions, the IRS may send you a letter requesting proof of your donations. If the IRS is satisfied with the evidence provided, it leads to a positive outcome for the audit.
2. Field Audit
The field audit represents the most comprehensive type of evaluation performed by the IRS. In such instances, an IRS expert will oversee the examination at your residence or business location.
Typically, field audits are initiated when the IRS is investigating more than just a couple of deductions. Generally, these audits are quite extensive and will examine nearly all aspects of your tax return.
3. Office Audit
An in-person audit conducted at a local IRS office is called an office audit. These audits tend to be more comprehensive than those conducted via mail and typically involve questioning by an auditor regarding the information provided in your tax return.
During an office audit, you must present certain documents, including your business records and personal bank statements, and receipts. You also have the right to bring an accountant or attorney to represent you during these meetings.
IRS Audit Guide for 2024
1. Receiving an IRS Audit Letter
When you receive the IRS audit letter, the IRS audit begins.
This letter may seek further information regarding specific details on the tax return, such as itemized deductions, eligibility for credits, or filing status. Often, the letter will request supporting documentation, such as copies of receipts.
Alternatively, it may inquire about income that has not been reported. These letters are referred to as Information Document Request Letters (IDR).
2. Responding to the IRS Audit Letter
The auditors mention information in their IRS audit letter and usually send one or more Information Document Requests (IDR). You must submit the records and data the IRS asks for.
This includes all the proof that backs up the numbers on your tax return. A well-prepared response letter should be included with the documents you send. Here, planning and strategy memos are “privileged information” and not required to be submitted.
So, keep all audit-related documents secure because losing them can make it hard for the IRS to do its job and may result in severe penalties for you. Never provide false statements or submit fake documents to the IRS, as it will violate the laws.
3. Submitting Required Documents
Taxpayers must keep their books and records up to date. This includes receipts and, for businesses, bookkeeping and accounting records. You can use accounting software, like QuickBooks Online, or hire an accountant, like Virtue CPAs.
The IRS usually asks for bank and credit card statements first. However, these statements don't provide final proof of income or expenses, they are a good starting point.
It is the taxpayer's responsibility to prove they qualify for a deduction. The best way to do this is with receipts. Even if expenses were paid in cash, the IRS still requires receipts to support deductions.
If W-2s or 1099s are not available, you can request Wage and Income Transcripts from the IRS. These records will provide the missing income and expense information. However, they do not include state tax withholding details.
If records are missing, the taxpayer should estimate expenses using a reasonable method. Here, you can use the IRS's Form 433 for estimating expenses for collection. This approach reduces the chance of issues with the IRS.
Taxpayers can get a deduction under the “Cohan Rule” if they reasonably estimate their expenses. You need to show the auditor how you calculated these costs. Still, estimates are not allowed for travel, entertainment, and business gifts, and the rule will not apply.
4. Hobby Losses Result in IRS Audit Letter
You cannot subtract losses from a hobby from your other income. The IRS looks at a hobby loss when it thinks that a money-losing activity is just a hobby, not a business. Your intent is important in the hobby loss audit.
The IRS identifies 9 factors to determine if an activity is a business or just a hobby, which are mentioned here:
- Is the business done professionally?
- The expertise of taxpayers and/or their advisors.
- The effort and time spent by the taxpayers in continuing the activity.
- Expectation of an increase in the worth of the activity's assets.
- Result of the taxpayer engaging in similar or distinct activities.
- The taxpayer's income or losses from the activity in the past.
- Evaluation of any extra benefits that may come from the activity.
- The financial status of the taxpayer.
- Aspects of the activity that bring enjoyment or fun
5. Cash-based Businesses in IRS Audit
IRS is more concerned with Cash-based businesses. That’s why IRS auditors extensively check expense forms, bank deposits, point-of-sale records, and 1099 forms to confirm that all cash income is reported on the tax return.
On the expense side, they will look for proof of payment, usually in the form of receipts, to support deductions claimed. They will also verify that the expenses are normal, necessary for that type of business, and consistent with industry standards.
6. 30-Day Letter
Near the end of the audit, the auditor will outline the suggested changes based on the government form Structure 4549, also known as a 30-day Letter. You have the right to admit this or not, also you can appeal.
If you accept the proposed adjustment to your tax return, you must pay any additional tax, along with penalties and interest. The taxpayer can also choose to set up a payment plan for the amount owed, such as an instalment agreement or an offer of compromise.
7. IRS Appeals
If you disagree with the changes in the 30-day Letter, you have 30 days to take the case to IRS Requests and appeal them. The staff at IRS Requests is usually very reasonable and eager to resolve the issue fairly.
Requests provide a way to settle the audit without going to court. You can achieve great results at IRS Requests, including getting penalties removed.
8. 90-Day Letter
If a taxpayer does not reply to a 30-Day Letter, the IRS will issue a Notice of Deficiency. This allows the taxpayer 90 days to file in the US Tax Court. If the taxpayer has less than one year left on the audit statute of limitations and does not agree to extend it, they may not receive notice.
9. US Tax Court
The case will initially go to IRS Appeals, so filing in the US Tax Court doesn't always mean going to court. As mentioned earlier, IRS Appeals is a great place to resolve issues reasonably and cost-effectively. If the case isn't resolved there, it will go back to the US Tax Court for litigation, which can be quite expensive.
10. IRS Collections
The IRS will take strong action to collect any extra taxes, penalties, and interest from the audit if the taxpayer fails to file in tax court within 90 days. This could lead to liens, levies, and garnishments.
When the tax debt is with IRS Collections, there are several options available for the taxpayer to resolve the debt. These include making an offer in compromise, setting up a payment plan, or requesting currently not collectible status. Each option has its pros and cons.
11. Substitute for Return
A substitute for return is a tax form created by the IRS to help taxpayers. This form may not allow individuals to claim deductions and credits they qualify for because the IRS does not know each taxpayer's situation.
If this happens, the IRS will issue a 90-day notice of deficiency CP3219N, suggesting a tax assessment. The taxpayer has 90 days to file the overdue tax return or appeal in Tax Court. If they do not do either, the IRS will proceed with the recommended assessment.
A person should file their tax return to benefit from any exemptions, credits, or deductions they qualify for, even if the IRS creates a substitute return. The IRS usually updates the account to show the right numbers.
The IRS will likely create a tax return for these taxpayers that leads to a tax bill. If this bill isn't paid, the collection process will begin. This could involve actions like wage garnishment or placing a lien on their property.
If a taxpayer continues to not file, they may face more serious consequences, such as extra fines or even criminal charges.
Conclusion
An IRS audit can occur for anyone if the IRS identifies a valid reason. Therefore, it is essential to file your tax return with utmost accuracy, ensuring that all numbers and accompanying documents are error-free.
However, in the hectic tax season, filing a tax return can be stressful for you due to the complex tax compliance and non-negotiable tax deadlines. But you can simplify this process by connecting with us.
Virtue CPAs is one of the most reliable taxation firms in Atlanta, USA. We are a team of professional tax consultants and CPAs to handle your tax deadlines, making your tax return filing exempt from IRS audit, and making you tension-free in tax season.
Our experience in managing the IRS audit tax has made us the first-choice CPAs for our clients to maintain tax compliance with IRS audits and IRS auditors.
Contact us now!
FAQs
The duration of an IRS audit changes based on the audit type, the complexity of the issues, how easily information can be obtained, the availability of both parties for meetings, and if you are accepting the result or not.
However, Most IRS audits are settled in around five to six months, but some may take longer.
Here, if the taxpayer has well-organized files, the audit can be completed more quickly. If the taxpayer and their CPA decide to appeal to the audit's decision, it can take up to a year or more.
Automated Under-Reporting (AUR) audits are a type of mail audit, mainly handled by computers.
The AUR Audits begin with IRS Notice CP2000. This notice is sent when data from an outside source, like a 1099 or W-2, does not match what the taxpayer reported on their tax return.
Notice CP2000 is also known as a Notification of Underreported Income. Taxpayers should reply quickly to this notice, usually within 30 days.
If you ignore Notice CP2000 or if the extra information you've been asked to provide is not accepted, the IRS will issue another notice, called a Statutory Notice of Deficiency. It explains why the IRS wants to change the tax and how they came to that decision.
The notice also says that you can appeal the decision to the Tax Court if you wish. To protect your legal rights, it is important to reply to this notice within the given timeframe.
