How to Prepare for a Tax Audit

Let’s say you’ve just received a letter from the IRS notifying you that you have been “selected” for a tax audit. After your heart rate takes an unwelcome leap, you may wonder “Why me?” or “What am I supposed to do?” To help you answer those questions, here are helpful steps to take beforehand — and things to keep in mind during the audit — so you can make the best of the situation.

What is an IRS audit?

An IRS audit is a review of an individual’s or organization’s accounts and financial information to ensure you are complying with tax laws and reporting a correct amount of tax. The IRS conducts audits either by mail (known as a correspondence audit) or through an in-person interview to review your records. The interview may be at a local IRS office (i.e., an office audit) or at the taxpayer's home, place of business or accountant's office (i.e., a field audit).

How to prepare for an audit

You will receive notification of an audit in a letter from the IRS (not a phone call or text) that will instruct you on how and when to present your records. If the audit is being conducted by mail, the address to mail the requested records to will be on your notice. If the audit is being conducted in person, you’ll be instructed to call and schedule an appointment with an agent either in an IRS field office, your place of business or your home.

If you’re notified of an audit, the IRS suggests that you:

• Organize the records you send or bring with you to help speed the process along and reduce errors or misunderstandings. Organize your tax records by year and type of income or expense and include a summary of transactions.
• Promptly mail copies of any correspondence — never the original records — to the address listed.

Here are the types of records the IRS will most likely request to see how you came up with the amounts you reported:

The IRS also notes that you must include the circumstances surrounding any document you send.

What happens during an audit

During the audit, you’ll be asked to present specific documents that support the income, credits or deductions you claimed on your return. From the IRS’s perspective, you would have used all of these documents to prepare your return. Therefore, the request should not require you to create something new. That makes the process sound simple, but to help you through it, keep these tips in mind:

• Provide only the documents needed to support the point under discussion. Never give the auditor more information than requested.
• Answer only the questions asked. Provide succinct answers, and always respond honestly and briefly. If you’re unsure of how to answer a question, make a note of it and offer to get back to the agent with answers.
• Remain courteous, be cooperative and stay calm. No matter how frustrated you may get, avoid being argumentative, stubborn or belligerent.

If you feel you are being treated unfairly or question why certain information is being requested, refer to Publication 1, Your Rights as a Taxpayer, which explains your rights as well as the examination, appeal, collection and refund processes and your right to professional and courteous treatment by IRS employees.

How long does an IRS audit take?

The length of an audit depends on several factors — the type of audit (e.g., correspondence vs. field), the complexity of the issues, the prompt delivery of information requested, the availability of both parties to meet as needed, and whether you agree or disagree with the audit findings.

To help expedite the audit, pull together as much info as possible beforehand, try to respond promptly to requests and make yourself available for appointments and questions.

Audits can take a while, so be prepared for weeks, months and in some cases, years of correspondence, appointments and follow-ups. But keep in mind that the IRS only has three years  in typical circumstances to complete their audit if your case doesn't fall under any exceptions.

What are the potential outcomes of an audit?

If there is one goal that you and the IRS share during an audit, it’s for the process to be resolved as soon as possible. Here are the potential outcomes of an audit:

• No change: You have substantiated all of the items being reviewed, which results in no changes.
• Agreed: The IRS proposed changes and you understand and agree with the changes.
• Disagreed: The IRS has proposed changes and you understand but disagree with the changes.

If you agree with the audit findings, you will be asked to sign the examination report or a similar form depending upon the type of audit conducted. If you disagree with the audit results, you can:

• Request a conference with an IRS manager.
• Use mediation offered by the IRS.
• File an appeal, if there is enough time remaining on the statute of limitations.

If you end up owing the IRS money in unpaid taxes, you may also face a “failure-to-pay” tax penalty, as well as interest that starts accruing the day after the tax filing due date. If you owe money, there are several payment options available. Publication 594, The IRS Collection Process, explains the collection process in detail.

Avoid these red flags when you file

The amount of audits that the IRS conducts is continuing to drop. But there are still certain things that could raise a red flag and increase the possibility of getting audited, including:

• Failing to report all taxable income.
• Taking higher-than-average deductions.
• Running a business or working from home.
• Taking large charitable deductions.
• Making mathematical errors or omissions.

Conversely, reporting numbers that appear to be too conveniently “rounded up” (e.g., an adjusted gross income of “$100,000”).

To avoid the attention of the IRS, make sure you carefully review your calculations before you put pen to paper or hit “submit.” If you have any tricky questions about new tax laws, how to report different sources of income or what deductions you can legally take, consult a tax accountant or attorney for assistance.

Having your taxes professionally done by a qualified, reputable person or organization may reduce your chances of being audited. They can ensure your return is filed as accurately and honestly as possible — and also know the common red flags the IRS looks for.

The good news in all this? Remember that only a very small fraction of tax returns is audited, and that not all audits are complicated or stressful — especially the correspondence audits. Sometimes it’s just a matter of simply hanging on to important documents and then providing the information the IRS requests.