TAX AUDITS
IRS Tax Audit
The IRS Tax Audit Process and Common Audit Triggers
If you are facing an IRS tax audit, you may be wondering what to expect or why your return was selected for further examination. It’s important to understand common triggers for audits and how the IRS tax examination process works.
Common Audit Triggers
Most tax returns are processed by the IRS without issue, but some factors may increase the risk of an examination. Some of the most common audit triggers include:
Cryptocurrencies and Digital Currencies
Cryptocurrencies, such as Bitcoin or Ethereum, and other digital currencies may attract the attention of the IRS.
At the federal level, cryptocurrency is treated as property. The Infrastructure Investment and Jobs act of 2021 also implemented reporting requirements for digital assets like cryptocurrency.
Advance Child Tax Credit Payments
Under the 2021 American Rescue Plan, qualified Americans were given an advance payment of up to half of the 2021 Child Tax Credit. In addition, taxpayers were able to claim the other half of the credit when filing their 2021 taxes.
Advance Child Tax Credit payments were mentioned specifically by the IRS in their 2022 Audit Plan. The IRS stated that they would be looking closely at these advanced periodic payments to ensure they are accurate and only made to eligible taxpayers.
Net Operating Losses
When businesses have losses, a net operating loss (NOL) may be carried forward or backward to offset income. The CARES Act amended the rules for NOLs when filing amended or tentative claims, which puts many businesses at a higher risk of being audited.
High Income
Those who earn more than $200,000 are more likely to attract the IRS’s attention and are at a higher risk of being audited. Individuals who earn substantial income are more likely to have investment income with complex reporting requirements, like capital gains or real estate transactions.
Early Retirement Account Withdrawals
Taking early withdrawals from tax-advantaged retirement accounts can trigger an IRS audit. Early withdrawals must meet certain exceptions to be non-taxable. If these withdrawals go unreported, they may be subject to an additional 10% penalty.
Being Self-Employed
Working as a self-employed individual or independent contractor has its perks, but the IRS may look at your returns with greater scrutiny. With sole proprietors and independent contractors, there’s a greater risk of income being unreported or personal and business assets to be comingled.
Small businesses tend to attract the attention of the IRS.
Taking the Home Office Deduction
It’s easy to assume that working from home automatically qualifies you for the home office deduction. However, there are very strict rules for claiming this deduction, and the IRS may be keen to investigate whether you are in compliance with these requirements.
In order to qualify for the home office deduction, you must use your home office space regularly and exclusively for business use and it must be your principal place of business.
Having Assets Abroad
Taxpayers may be subject to a Foreign Bank Account Report (FBAR) audit if they:
- Have $10,000 or more in foreign assets and have not filed an FBAR
- Are suspected of misreporting income and assets on their FBAR
FBAR audits can be exceptionally complex and failure to comply can lead to significant penalties and potential criminal prosecution.
These are some common triggers for an IRS audit, but the IRS may also select returns for further examination if:
- They suspect tax avoidance.
- They are from a large corporation.
- Information doesn’t match up (e.g. data from a 1099 interest statement does not match the reported income).
- A return receives a certain computer score. Returns are given numeric scores, and those with the highest scores may be selected for further examination.
The IRS Tax Audit Process
Being faced with an audit can be scary and intimidating. Understanding how the process works can help make the ordeal a little bit less stressful.
Taxpayer Rights
If faced with an audit, it’s important to understand your rights as a taxpayer.
These include the right to:
- Representation, either by yourself or an authorized representative
- Professional treatment by the IRS employee
- Know why you are being audited, how the IRS will use your information, and what will happen if you do not provide the requested information
- Appeal disagreements
- Privacy and confidentiality regarding tax matters
IRS Tax Examination Methods
The IRS conducts tax audits in one of two ways: by mail or through a face-to-face examination. The return’s complexity will determine whether the examination will be done via mail or in person.
By Mail (Correspondence)
Correspondence examinations are typically performed for simple Form 1040 returns. Issues are usually related to:
- Additional child tax credit
- EITC (Earned Income Tax Credit)
- Medical expenses
- American Opportunity Tax Credit
- Employee business expenses
With correspondence examinations, taxpayers can mail in their documents and do not have to travel to an IRS office.
Face-to-Face
Tax Compliance Officers are charged with performing face-to-face examinations at IRS offices. While this type of examination does require an in-office meeting, it may not necessarily require a visit to the taxpayer’s office to review records or assets.
Issues that may trigger a face-to-face examination can include:
- Pensions
- Tips
- Rents
- Annuities
- Scholarships
- Fellowships
- Royalties
- Deductions for business-related expenses
- Complex itemized deductions
Complex returns may require an audit by a Revenue Agent, or RA. RAs perform examinations at the taxpayer’s place of business.
What Documents are Needed for an IRS Tax Audit?
Because audits are focused on certain aspects of a tax return, the documents required may differ from one examination to the next. However, the types of documents often requested by the IRS include:
- Receipts
- Bills
- Canceled checks
- Loan agreements
- Legal papers, such as property acquisition or divorce settlements
- Medical and dental records
- Tickets
- Diaries or logs
- Theft or loss of documents
- Employment documents
- Schedule K-1
The notice you receive from the IRS will provide information on which records you will need to present and how to present them.
IRS tax audits can be incredibly complex, and non-compliance can have significant consequences. An experienced tax attorney can help you navigate these difficult waters to give you peace of mind and make the process as smooth as possible.
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Resolving Federal IRS Matters Nationwide
Delia Law can help you take control of your IRS situation — whether it’s been hanging over your head for years or just arrived in the mail. We focus solely on federal tax matters, and we treat every case like it matters — because it does. From IRS notices and tax audits to collections and litigation, we can help you resolve your issue.
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