If you’re under audit by the IRS, it’s important to understand how to protect your rights during an audit.
Types of IRS Audits
Many people will deal with an IRS audit at some point in their lives. It may be a simple correspondence audit, or it may be a field visit to your business.
Correspondence Audit Program
A correspondence audit is conducted through mail. Such audits are for issues that involve records that can easily be submitted by mail. Examples of issues that are covered by a correspondence audit include:
• Dependent Exemptions
• Earned income tax credits (EITC)
• Child Care Credits
• Adoption Credits
• Educational Credits
• Certain itemized deductions and Schedule C expenses
While correspondence audits are less intimidating since they do not involve a face-to-face audit, they can be extremely frustrating.
The case could be handled by a different person each time you call the IRS or submit documents.
You may have to go back and forth over the course of several months to get an issue resolved.
Automated Underreporter Program (AUR)
The IRS uses computer-matching and error-checking programs to verify the accuracy of tax returns. The most common notice generated by the AUR is a Notice CP2000.
A CP2000 informs the taxpayer that there is a discrepancy between income shown on the tax return and income that was reported by others.
For example, if you had cancellation of debt (which is considered income), the creditor will issue a 1099-C to you and file it with the IRS. If your tax return does not include that income, the AUR will generate a Notice CP2000 informing you of the mismatch.
An office audit is a face-to-face examination with a Tax Compliance Officer (TCO). The majority of cases worked by a TCO involve Schedule C issues.
The TCO will audit up to 4 vital issues and possibly additional issues on the return with managerial approval. If you are chosen for an office audit, you will receive an examination letter, requesting you to call and set up a day and time to have your return and supporting documents examined.
The TCO will also send you an Information Document Request (IDR) which contains a list of documents that the TCO wants to review.
TCOs are trained to not only verify questionable expenses and credits on the tax return, but to also look for unreported income. Such examinations can be highly invasive and difficult for clients.
However, TCOs are not allowed to automatically request bank statements without meeting specific criteria in the Internal Revenue Manual.
Field audits are conducted through on-site visits by a Revenue Agent (RA). Unlike TCOs who examine individual, self-employed, and disregarded entity returns, RAs examine only business returns.
In addition, there are RAs in the Small Business/Self-Employed (SB/SE) department and RAs that are assigned to Large Business and International (LB&I). SB/SE revenue agents will audit business returns with assets under $10 million.
The first contact with an RA is through a letter providing a time, date, and place of examination of the taxpayer’s books and records, along with an Information Document Request (IDR). If you have a representative, the examination can be conducted at the practitioner’s office.
A field audit will always include a reconciliation of income from books, records, and bank statements to the tax return. The revenue agent will already have picked some issues to review prior to the examination but will examine additional issues as warranted.
How to Prepare for an Audit
If there’s ever a reason to hire a tax professional, an IRS audit should be at the very top. Unless your records are in perfect order and you have records to substantiate every deduction taken on the return, do not attempt to handle this on your own.
After you’ve hired a tax professional, you and the representative should have an honest discussion about your tax returns and identify any issues, such as expenses that you may have accidentally overstated or are unable to provide documents. Your representative may help limit the damage.