Tax Audit

A tax audit is an examination of a taxpayer’s financial and tax-related records by the Internal Revenue Service (IRS) or other tax authorities to ensure that the taxpayer has complied with tax laws and regulations. The audit may be conducted in-person, by mail, or through electronic means.

Tax audits can be random or targeted, based on specific criteria such as the type of income reported, the size of the business, or previous audit history. The goal of the audit is to determine if the taxpayer has accurately reported their income, deductions, and credits and whether they have paid the correct amount of tax.

During the audit, the IRS or other tax authority will review the taxpayer’s financial records, such as bank statements, receipts, invoices, and other documentation, to verify the accuracy of the tax return. If discrepancies or errors are found, the taxpayer may be required to pay additional taxes, interest, and penalties.

It’s important for taxpayers to keep accurate and complete records and to respond promptly and honestly to any requests or questions from the IRS or other tax authorities. Hiring a tax professional, such as a Certified Public Accountant (CPA), may also be helpful in navigating the audit process.

Tax Audit example

Let’s say you’re a self-employed graphic designer who files a Schedule C as part of your individual tax return. You report $100,000 in gross receipts for the year, and you claim $30,000 in business expenses, leaving you with $70,000 in net profit.

The IRS selects your tax return for a random audit, and they request copies of your business records, including receipts, invoices, and bank statements. They also ask for documentation to support your claimed expenses.

During the audit, the IRS notices that you claimed a $10,000 deduction for a home office. They ask for documentation to support this deduction, such as a floor plan of your home showing the square footage of the office space, utility bills, and rent or mortgage payments.

Upon review, the IRS determines that your home office deduction was not properly supported, and they disallow the deduction. As a result, your net profit increases to $80,000, and you owe additional taxes, interest, and penalties on the disallowed deduction.

In this example, the taxpayer’s tax return was selected for a random audit, and the IRS focused on the home office deduction as an area of potential noncompliance. The audit resulted in additional taxes, interest, and penalties due to the disallowed deduction.

Tax Audit features

• Examination of Taxpayer Records: Tax audits involve a detailed review of the taxpayer’s financial and tax-related records to ensure that the information reported on the tax return is accurate and complete.
• Notification: Taxpayers are typically notified of an audit by mail, and the notification will specify the type of audit and the items being examined. The taxpayer may be asked to provide additional documentation or answer specific questions.
• Examination Techniques: The IRS or other tax authority may use various examination techniques during an audit, including correspondence, phone interviews, or in-person meetings.
• Scope: The scope of the audit will vary depending on the type of audit and the items being examined. The audit may be limited to specific items on the tax return or may include a more comprehensive review of the taxpayer’s financial records.
• Results: The audit may result in additional taxes, penalties, and interest owed by the taxpayer if errors or discrepancies are found. In some cases, the audit may result in a refund for the taxpayer if the audit reveals that the taxpayer overpaid their taxes.
• Appeals: Taxpayers have the right to appeal the results of an audit if they disagree with the findings. The appeals process involves a review by an independent IRS appeals officer.

Tax Audit Types

• Correspondence Audit: This is the most common type of audit and is conducted by mail. The IRS will request additional information or documentation to support specific items on the tax return, such as income or deductions.
• Office Audit: An office audit is conducted at an IRS office or local tax agency office. Taxpayers will receive a notification by mail requesting that they bring specific documentation to the audit appointment.
• Field Audit: A field audit is conducted in-person at the taxpayer’s place of business or home. This type of audit is typically more comprehensive than an office or correspondence audit and may include a review of the taxpayer’s books and records.
• Limited Scope Audit: A limited scope audit is focused on specific items on the tax return, such as a particular deduction or credit.
• Comprehensive Audit: A comprehensive audit involves a more thorough review of the taxpayer’s financial records, including all aspects of the tax return.
• Automated Underreporter (AUR) Program: The AUR program is used to identify discrepancies between information reported on tax returns and information reported by third-party sources, such as employers or financial institutions.
• Taxpayer Compliance Measurement Program (TCMP): The TCMP is a random audit program that selects tax returns for examination based on statistical sampling techniques.