You’re Being Audited By The IRS – How Bad is It?
Editor’s Note: At H&R Block, we work to help demystify the complex and confusing and help our clients wherever possible. So here’s what you should do when you are being audited, and when you should call in the experts (that’s us).
On a scale of 1 to 10 (10 being the worst), being audited by the IRS could be a 10. Audits can be bad and can result in a significant tax bill. But remember – you shouldn’t panic. There are different kinds of audits, some minor and some extensive, and they all follow a set of defined rules. If you know what to expect and follow a few best practices, your audit may turn out to be “not so bad.”
A little background first. There are three types of IRS audits: mail, office and field audits.
1. Mail audits
Mail audits are fairly routine. They require you to mail in documents responding to specific questions or requests for information from the IRS. Mail audits make up 77% of all audits.
2. Office and field audits
On the other hand, office and field audits are much more serious. The IRS will not only ask for information to validate your deductions and credits, but it will also look closely at your lifestyle, business activity and income to see whether your tax return is accurate. Most tax evasion cases start from field audits. But don’t worry – the IRS prosecutes few taxpayers for tax evasion (about 2,000 every year). The IRS saves criminal prosecution for the most egregious tax evaders.
3. CP2000 notice (underreporter inquiry)
There’s also another way the IRS questions tax returns, but it’s not technically an audit. It’s the underreporter inquiry, or CP2000 notice, and it’s very common. The IRS sends almost 4 million of these every year. The CP2000 is a discrepancy notice that proposes a specific increase in taxes on your return. The IRS automatically sends these notices when there’s a mismatch between income you reported on your return and information that your employer or other payer provided to the IRS through statements, such as Form W-2 and Form 1099. A common example is when taxpayers don’t report Form 1099-MISC income from work they did as an independent contractor during the year.
How common is being audited?
Here are some numbers that show how common – or uncommon – the different types of audits can be:
- About 150 million total federal tax returns are filed each year
- The IRS audits less than 1% of filers
- Almost 90% of audits result in a change to the tax return
- For mail audits, the average amount owed is more than $7,000
- For office and field audits, the average amount owed is $65,000
- The IRS sends underreporter notices to about 2.5% of filers
- About 66% of underreporter notices result in additional taxes owed
- For underreporter notices, the average amount owed is about $1,500
As unpleasant as an IRS audit can be, it won’t go away. It’s important to respond. If you don’t, you will get a tax bill for additional taxes, and perhaps even penalties. Learn how to handle an IRS audit.
Here are a few things you should do to get the best results in an audit:
Consider hiring a tax professional immediately, especially if you are not fluent in “tax.” Unless you can “speak IRS” and can clearly articulate your tax return position to the IRS, you shouldn’t try to handle it yourself and hope for the best. Tax professionals trained in IRS audits will provide the response needed to clearly communicate your tax position. If there’s an adjustment, a tax professional can help address proposed penalties. Learn about H&R Block Tax Audit & Notice Services.
Make your responses complete and on time. Most audits and all underreporter inquiries require corresponding by mail with IRS processing centers. There is no specific person assigned to your case, so the person viewing your response will rely on the quality and completeness of your response to interpret your tax position. If you want the best results, reply well before the deadline with an organized and thorough response that explains the items in question. Missed deadlines and incomplete responses lead to more notices and a higher likelihood that the IRS will close your audit and assess you additional taxes.
For office and field audits, prepare as if the IRS were auditing multiple years and your lifestyle. As the statistics show, office and field audits can result in a very high tax bill. That’s because the IRS looks to see whether there is any unreported income on the return. For example, the IRS can go through your bank statements and question deposits. Unexplained deposits can be considered taxable income if you can’t prove the nontaxable source, such as a gift or nontaxable sale of assets. Be prepared with an answer to these inevitable questions. A tax professional will be extremely valuable to help you prepare for office and field audits. Many taxpayers seek expert representation for these types of audits.
Assert your appeal rights when needed. Know that the auditor’s decision is not final when you file an amended tax return. The first appeal is made to the auditor’s manager. The second appeal is made to the IRS Office of Appeals. During the appeals process, it’s important to respond by all deadlines or you will lose important appeal rights.
So, if you are being audited…. how bad is it? Potentially, a 10. But getting help from a tax professional, making timely responses and having thorough documentation mean that you can get through an audit with the best possible outcome.
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Related tax terms
Related IRS notices
IRS Notice CP75 - Exam Initial Contact Letter - EIC Entire Refund Frozen
IRS Letter 566 - The IRS Has Selected Your Tax Return For Audit
IRS Letter 525 - The IRS is Auditing Your Form 1040 and Needs a Response From You
IRS Notice CP2501 - Your Tax Return Doesn't Match the Information the IRS has on File