How Tax Auditing Works
According to the Internal Revenue Service, only 1 percent of tax filers received an audit notice in the 2009 fiscal year. That is a small fraction of the hundreds of millions of individuals and businesses who reported their financial information to the agency. Still, fear and confusion are associated with tax audits. Not only are tax audits few and far between, but if you understand the process, you can avoid them completely.
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What Triggers a Tax Audit?
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A tax audit occurs when the IRS or a state government equivalent decides to further investigate a specific return. The return can be from a business or individual; the audit is triggered when there is a discrepancy in the information provided. These include suspicious or incorrect tax deductions, under-reported income and other inconsistencies.
The Audit Process
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The IRS sends a notice in the mail when an audit is to be performed and failure to cooperate results in either a court order or a fine. There are two types of audits: a paper audit, in which additional information is requested, and a field audit, when an in-person interview is conducted. For the paper audit, you must send in materials that support your return, such as bank statements, canceled checks and receipts. During the in-person audit, the IRS agent asks for explanations of all discrepancies. It is best to be represented by a lawyer or a tax professional during the interview. If unsatisfied after the review, the agency will recalculate the tax return and impose a penalty.
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The Appeal Process
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After the audit, the IRS sends an audit report, which contains its conclusion. The report can be appealed within 30 days of receiving it. During the appeal conference, you speak with a settlement officer who played no role in the original audit. However, if the appeal is unsuccessful, you can lodge a second appeal with the United States Tax Court. If the contested amount is less than $50,000, the court allows for a small claims filing. However, the court’s judgment on a small claims case cannot be appealed. Alternatively, you can elect to file the appeal as a regular case, whether the contested amount is less than or more than $50,000.
How to Prevent a Tax Audit
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The best way to prevent an audit is to be accurate when completing a tax return. For complicated returns, use experienced tax professionals as they are trained to avoid the inaccuracies that lead to an audit. And if there is an audit, the tax preparer is equipped to remedy the situation. Also, avoid an audit at the state level because the state will report any tax inaccuracies to the federal government, which will cause the IRS to look closer at your past returns.
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