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Greg O’Brien, CPA, CTS
February 23, 2024

How Do IRS Audits Work? A Comprehensive Guide

Tax audits can be a source of stress and anxiety for many individuals and businesses. However, understanding the process and knowing what to expect can help alleviate some of the uncertainty. In this comprehensive guide, we will explore how IRS audits work and provide valuable insights into navigating the audit process. Our goal is to empower you to effectively handle an audit and protect your tax-free wealth.

Section 1: Receiving the IRS Audit Letter

The first step in the tax audit process is receiving a written notice from the IRS. It is important to note that the IRS always communicates through mail and never via telephone, email, or social media. The audit letter will outline the specific tax returns under examination, the scope of the audit, and any additional documentation requested. It will also indicate whether the audit will be conducted through correspondence, at an IRS office, or at your place of business.

Upon receiving the audit letter, you will have 30 days to respond either by mail or by phone. This time frame allows you to seek professional representation, gather the necessary documentation, and prepare your case. It is highly recommended to engage the services of a qualified tax strategist or CPA to navigate the audit process effectively.

Section 2: Understanding Which Tax Returns Can Be Audited

The IRS has the authority to audit any tax return within a specific time frame. Generally, the statute of limitations for audits is three years from the due date of the return or the date it was filed, whichever is later. However, there are circumstances where the IRS can extend the audit period up to six years. These include situations where significant errors, improper reporting, tax fraud, or undisclosed foreign income/assets are suspected.

To ensure compliance and preparedness for potential extended audits, it is advisable to retain business tax returns, statements, and receipts for a minimum of six years. Keeping meticulous records will not only facilitate the audit process but also help minimize any potential tax liabilities.

Section 3: Reasons for Selection in IRS Audits

While some audits are randomly selected, most audits are triggered by specific factors. The IRS utilizes sophisticated computer systems that flag tax returns with a high likelihood of errors or unreported income. Discrepancies between reported values and information provided by associated parties, such as employers or banks, can also trigger an audit. Additionally, individuals or businesses operating in cash-intensive industries, dealing with cryptocurrency, or having undisclosed offshore assets may face a higher risk of being selected for an audit.

Small businesses, in particular, are more vulnerable to IRS audits. Maintaining accurate and up-to-date bookkeeping records is crucial for reducing the likelihood of triggering an audit. Seeking professional assistance for small business tax returns can provide valuable guidance and ensure compliance with IRS regulations.

Section 4: Step-by-Step Guide to the Audit Process and Tax-Free Wealth Protection

Step 1: Prepare the Requested Documentation

Once you receive an audit notice, you will have a specified time frame to gather and prepare the requested documentation. The extent of the documentation required will depend on the type of audit being conducted. For correspondence audits, you may only need to submit specific receipts or supporting documents. In contrast, office or field audits may require a more comprehensive examination of deductions, expenses, and income sources.

It is highly recommended to engage the services of a tax professional, such as a CPA to assist with the preparation of documentation. These professionals possess an in-depth understanding of tax laws and can help ensure that your responses and supporting documents align with IRS requirements.

Step 2: Present Your Documents

The next step in the audit process is presenting your documents to the IRS. The method of presentation will vary depending on the type of audit. For correspondence audits, you will submit your response and documents by mail. Office audits require you or your representative to visit the nearest IRS office and present the documentation in person. Field audits involve the IRS agent visiting your home or place of business to review the documents.

It is worth noting that the majority of audits are conducted entirely through correspondence. However, having professional representation can be invaluable in face-to-face audits, as it ensures compliance with IRS procedures and prevents potential miscommunications.

Step 3: Respond to IRS Requests and Advocate Your Position

Throughout the audit process, the IRS may request additional information or clarification regarding specific items on your tax return. It is essential to respond promptly and provide the requested information in the format specified by the IRS. If you have professional representation, your tax strategist or CPA will guide you in preparing the appropriate responses.

In cases where the IRS proposes adjustments to your return, you have the right to present your interpretation of the facts and tax law. It is crucial to articulate your position clearly and substantiate it with supporting documentation. The ultimate goal is to reach a resolution that minimizes any potential changes to your tax liability.

Step 4: Appeal the Audit Findings, if Necessary

If you disagree with the IRS findings, you have the option to appeal within a specific timeframe. The IRS Office of Appeals handles appeals and provides an opportunity to have an impartial review of your case. It is advisable to consult with your tax professional to determine the best course of action and navigate the appeals process effectively.

Section 5: When Tax Audits Turn Criminal

While most audits focus on resolving discrepancies and ensuring compliance, some audits can evolve into criminal investigations. Criminal tax investigations are initiated when tax fraud, tax evasion, substantial unpaid taxes, undisclosed offshore accounts, or money laundering activities are suspected. If your case turns criminal, it will be investigated by an IRS special agent and may be referred to the Department of Justice or the United States Attorney.

It is essential to note that criminal tax investigations are relatively rare compared to routine audits. However, it underscores the importance of maintaining accurate and transparent financial records and ensuring compliance with tax laws.

Audit Proof Your Business And Put It All Together

IRS audits may seem daunting, but with proper preparation and professional guidance, you can navigate the process successfully. Understanding the steps involved, gathering the necessary documentation, and engaging the services of a tax strategist or CPA can help protect your tax-free wealth. Remember, audits are an opportunity to address any discrepancies and ensure compliance, ultimately preserving your financial well-being.

At Anomaly CPA, we specialize in providing tax planning and audit support for individuals and businesses. Our team of experienced virtual CPAs is dedicated to helping clients protect their tax-free wealth and navigate the complexities of the tax audit process. Contact us today to learn more about how we can assist you in achieving financial success.

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