IRS tax audits are rare. Less than four out of every 1,000 tax returns were audited in 2022. However, if you find yourself the subject of an audit, preparing for what's ahead can reduce stress and enable you to approach the process competently and professionally. Here's how to prepare for a tax audit.
Why Tax Audits Happen
Before we dive into preparing for a tax audit, let's first talk about why they happen in the first place. Although tax audits are relatively uncommon, a few common triggers can lead to one.
Random selection is one reason—in some cases, tax returns are chosen for audit randomly. Other times, returns are chosen because of discrepancies and errors, including inconsistencies in income reporting, math errors, or missing documentation.
High-income earners, or those who engage in complex financial activities, may also face IRS scrutiny. And if your financial ratios differ significantly from other businesses in your industry, you may also trigger an audit.
It’s important to note that while these are common triggers, this is not an exhaustive list. If the IRS has chosen to audit you, here's a step-by-step guide on how to best prepare.
Gather Your Records
Collect all relevant records, including receipts, mortgage statements, brokerage statements, pay stubs, previous tax returns, and retirement account records. You may also want to contact a tax professional to review your tax returns and preemptively find the discrepancy.
Know Your Rights
In the event of an audit, you have certain rights to ensure fairness and transparency.
These include the right to:
- Professional and courteous treatment: The IRS is required to treat you courteously and professionally.
- Representation: You can represent yourself or have a CPA, tax professional, or attorney represent you.
- Privacy and confidentiality: Any information you provide during the audit must be confidential.
- Understand and appeal: You are entitled to know why you’ve been audited and have the right to appeal.
- Documentation: You are entitled to a copy of the audit report and any supporting documents.
- A timely process: All audits are expected to be carried out on time.
- Finality: Following the audit, you have the right to know the IRS’s final determination, including additional taxes, penalties, or interest owed.
- Appeal: If you disagree with the audit’s outcome, you have the right to appeal.
What Happens After the Audit?
Audits can end in a few ways. Either no changes will occur, you and the IRS will agree with the changes, or you will disagree with the IRS's conclusion and want to appeal.
Next, you will be given an audit report detailing the additional tax assessment, explaining how your return will change and how you can appeal it.
It is important to note that you are not required to sign the report immediately if you disagree. By signing the report, you waive your right to take the dispute to tax court.
Additionally, if there are any tax deficiencies, interest will accrue yearly from the original return's date until you settle the bill. And depending on the nature of the errors, you may face a penalty which is a percentage of the tax deficiency.
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