Filing your taxes can be challenging enough for the average American taxpayer. (Especially if you ended last year owing some money to Uncle Sam.) But throw in the possibility that the Internal Revenue Service (IRS) could come back at you with a tax audit after a few months—or even a few years—and sending that return can become downright nerve-racking.
Never mind that the IRS audited just 0.45% of individual tax returns in fiscal 2019. Or that the coronavirus pandemic forced the agency to temporarily suspend some of its compliance programs in 2020. Even the most fastidious of filers can get sweaty palmed at the mere thought of receiving an audit notice from the IRS.
This is an informative, high-level overview of tax audits and should not be considered tax advice. It’s always worth consulting a tax professional for any questions or concerns because taxes are complicated and highly personal.
A Few Facts About Tax Audits
Of course, it’s impossible to predict how many taxpayers will be audited in 2021—or why those folks might get the attention of the IRS. But here are a few facts about the process that could help you understand your risk and deal with audit anxiety.
A Compliance Contact Isn’t Always an Audit
When a taxpayer is contacted by the IRS, the next step isn’t necessarily a full-on audit of that person’s records. The agency’s computer system might have flagged the return for issues that can be resolved without an in-depth examination. According to the IRS, some of those reasons might include:
• The income a taxpayer reports on a return doesn’t match up with information provided by a third party. (The taxpayer uses a different number than the amount listed on an employer’s W-2, for example, or forgets to include income from investments.)
• There’s a math error on the return, or the filer is missing a form.
• The taxpayer failed to file a return, and the IRS is filing a substitute Form 1040 to determine the taxes owed.
• The IRS might be doing a compliance check to see if a taxpayer is meeting certain recordkeeping requirements.
The IRS usually sends a letter when it reaches out to ask for more information, and the letter should let you know specifically what the agency is looking for. The IRS says taxpayers may not even need to make contact unless:
• The taxpayer disagrees with the information provided;
• The agency requested more information; or
• The taxpayer owes some money.
However, if you have questions, you can write the IRS at the address listed on the notice or letter. (Allow 30 days for a response, and you may want to request confirmation from the post office or other delivery service). Or you can call the phone number in the top right-hand corner of the letter.
You shouldn’t ever receive a text, email, or phone call from the IRS asking for personal or financial information. If you do, the IRS website offers several steps for checking out and reporting any suspicious contact . If someone visits your home or business unannounced and claims to be from the IRS, ask to see some credentials. An IRS representative should be able to provide two forms of identification: a “pocket commission,” which describes the holder’s specific authority, and a Personal Identity Verification Credential. A criminal investigator should have a badge and the appropriate law enforcement credentials.
There Are Different Types of Audits
The IRS can conduct a taxpayer’s entire audit by mail, or it may require an in-person interview. Face-to-face audits are generally more complicated or wider in scope, and they might be held at an IRS location or a taxpayer’s home, business, or accountant’s office.
Whether it’s a correspondence exam or an in-person audit, you’ll get a printed list of specific records the IRS wants to see. If your audit is being managed by mail, you may be able to send the documents electronically or by mail. (Be sure to get a receipt for delivery.) Note the IRS will generally accept copies and they caution against mailing original documents in. If it isn’t possible to send the documents, you can request an in-person meeting.
If you need more time to respond to a correspondence exam, you can fax or email a request for an extension using the contact information in your IRS letter. Or, if you’re being asked to comply with an in-person exam, you can contact the auditor assigned to your case to request an extension.
Some Groups Face Higher Audit Rates than Others
According to IRS data , taxpayers who earn less than $25,000 annually, or more than $500,000, are more likely to be audited than other Americans.
For poorer taxpayers, that’s because the IRS automatically checks for mistakes or fraud related to the Earned Income Tax Credit (EITC), a benefit that may reduce the amount of taxes owed by workers who have a low to moderate income. The IRS says error rates on tax returns for those claiming the EITC, which it admits has some complex rules, are about 50%. But the agency also says those errors are generally quickly resolved.
Higher-income earners, who typically have more complicated returns, may face more arduous—and, therefore, lengthier—reviews. Those audits can take several years to complete.
Self-employed workers and those with side gigs also may get more attention if the IRS suspects they’ve omitted some income or inflated business deductions on their returns. Some examples of potential red flags include:
• There are specific rules workers who claim the home office deduction on their return must follow. (The space must be your principal place of business, for example, and you must use it regularly and exclusively for that purpose.) Taxpayers claiming this deduction may want to gather documentation to back up any expenses they use when calculating this deduction.
• The Tax Cuts and Jobs Act of 2017 tightened up the rules for anyone who earns income or claims expenses related to a hobby . (If the main goal is not to make a profit, the IRS doesn’t consider it a business.)
• Claiming net business losses over the course of several years may prompt the IRS to take a look at what’s been happening during that period.
• The IRS also will check what you claim as income against what your clients report paying you for each contract job. If there’s a discrepancy, there may be questions.
Good Record Keeping May Offer Protection
One way taxpayers can help make their interactions with the IRS go a bit smoother is to keep meticulous records. Careful records can help make tax preparation more straightforward—with less guesswork and more facts. And if the IRS has questions, the more complete your records are, the easier it can be to quickly check your math, figure out if perhaps you misinterpreted a rule, or determine if you simply made a typo when filling out your return. Plus, if the IRS requires supporting documents , you’ll be able to easily access, copy, and send or bring the requested paperwork.
The IRS usually looks at returns filed within the last three years when conducting an audit, and the agency advises hanging onto receipts, cancelled checks, mileage logs, and other documents for at least that long. But because an audit may go back further (typically no more than six years), it may make sense to retain certain records for a longer period. Taxpayers can check out recommendations for how long to keep various records on the IRS website .
Ignoring the IRS Could Be Costly
Take a deep breath and don’t panic or toss any correspondence you might receive from the IRS.
In a recent survey sponsored by the Jackson Hewitt Tax Debt Resolution Service, 22% of respondents said they had ignored a letter or notice from the IRS or state tax authority. Of that group, 32% said it was because they were overwhelmed or scared, and 32% said they didn’t know how to respond. But ignoring a request for information won’t help the situation—and it could end up costing more money in additional interest and penalty charges. Taxpayers who wait too long to respond to an IRS audit also could lose the right to appeal the results.
Another 30% of the survey group who ignored the IRS said they didn’t have enough money to pay the tax bill. If you think you owe more in taxes than you’ve paid, but you can’t come up with the full amount, the IRS advises paying what you can. You may be able to work out a payment plan , delay collection temporarily, or settle the debt for less than you owe.
No one can guarantee a return won’t be audited by the IRS—even if you aren’t doing any of the things most experts say might put you at higher risk. But if you’re honest about your income and your deductions, keep organized and complete records, take care to enter all information accurately—and double check your work—you may be able to avoid major problems should you get audited.
Taxpayers who prepare their own return may be able to reduce their errors by filing electronically: The error rate for paper returns is 21%, but it’s less than 1% for e-filers. Those who hire someone else to do their return should still try to review everything carefully before signing.
Finally, when it comes to filing your taxes, knowledge is power. Understanding all the rules and strategies that might apply to you and your family could help you lower your tax bill—now and in the future—and help keep you from making mistakes.
Feeling unsure about where to start? Check out SoFi’s Guide to Understanding Your Taxes for information that ranges from how to file your return and when to expect your refund to how your taxes can affect your finances (and vice versa). If you have specific questions, consider consulting with a tax professional who is able to offer advice personalized to your unique needs and situation.
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