Tax Audits Explained (Not As Scary As You Think)

The majority of taxpayers, whether they are just starting their taxes or have already filed, are understandably curious about IRS tax audits. However, the reality is that the risk of being audited is greatly exaggerated by the general public. While it is important to always be accurate and thorough on your tax return, the actual likelihood of being selected for an audit is relatively low. 

In fact, less than 1% of all taxpayers experience an audit in any given calendar year. Of those audits, only 23% resulted in a face-to-face encounter with the IRS in 2023. Most inquiries are resolved through mail correspondence. The information below is a guide to tax audits should you ever find yourself in this situation.

What is an IRS audit?

An IRS audit is a review or an examination of financial information and accounts to ensure that the information reported on a tax return is correct according to tax law. During an IRS audit, the IRS will verify that the amounts reported are correct and ensure that no discrepancies need to be addressed.

The IRS may request several types of records during an audit, including income documents, expense records, proof of deductions and credits, investment and financial records, and other miscellaneous documents to support reported items on your tax return. 

Types of IRS Audits

The three types of audits are:

• Correspondence audits usually require you to provide information (or evidence) about very specific items made on your tax return.
• Office audits, which are slightly more involved, require you to go into an IRS office to discuss certain aspects of your tax return.
• Field audits are typically conducted at your home or business office where you work. This is the most comprehensive and in-depth type of audit to examine complex issues or for situations in which the IRS needs to look at an extensive amount of records. 

The IRS will let you know which documents are needed beforehand. As a general rule, it is best not to offer the IRS agent any information beyond what is specifically needed. Otherwise, you could generate additional questions from the IRS.

If your documents support the original return, you shouldn’t have a problem and the result of the audit will result in “no change.” If the auditor finds a discrepancy (and you agree), you can sign the documents and pay any taxes owed. 

If you disagree with the auditor’s findings, you can appeal the decision. 

Are IRS audits common?

Though audits have increased slightly in recent years, the chances of being audited are still low. For all individual returns filed for Tax Years 2013 through 2021, the IRS examined 0.44% of returns filed as of the end of fiscal year 2023. 

The 2023 IRS Data Book also shows that most audits are conducted via mail. In 2023, 77.3% of audits were handled via correspondence, while 22.7%  of audits were conducted in the field. The IRS reports that correspondence audits are cheaper in terms of the direct cost for the IRS and the burden of the taxpayer. 

In many cases, the IRS may be unable to match information reported to them versus what you reported on your tax return. Fortunately, it may be something as simple as providing additional information or an explanation to meet their requirements. Therefore, it is important to not automatically assume that the IRS is correct. Make sure to research the discrepancy and be prepared to respond to the IRS with the correct information if necessary. 

What triggers an IRS audit

An IRS audit is triggered when the IRS believes you may have provided incorrect information on your tax return. Let’s look at some of the most common triggers of an IRS audit so that you can take preventive measures to try to avoid them in the future.

You claim large losses.

If you claim an unusually large business loss or a loss that is disproportionate to the income being reported, you could potentially get audited. In addition, losses must be supported by legitimate business activities. The IRS will want to make sure your intention is to earn a profit and verify your business activity is not really a hobby. 

Claiming rental losses can also be a red flag for the IRS if they are substantial or not in line with industry norms. 

You claim uncommon or unusually large deductions.

If your deductions are uncommon or unusually large, your chances of getting audited are typically much higher than average. This is the direct result of taxpayers historically attempting to deduct non-business expenses, such as home telephone service, or including the square footage of living room or bedroom space to artificially inflate their home office deduction. Similarly, taxpayers who take large deductions, such as those with extremely high medical expenses or a large amount of miscellaneous deductions, could trigger an audit. Lastly, extravagant business deductions related to meals or excessive travel expenses have a higher likelihood of triggering an audit.

You have a large amount of charitable contributions.

If you claim a large charitable deduction,  including those amounts for non-cash donations, you have a greater chance of being audited. Documentation requirements for charitable contributions are stricter than they were previously.

You have a cash business.

The IRS knows that businesses with frequent cash transactions  (such as taxi driving, hair and nail salons, car washes, laundromats, and delis) can easily conceal income. To address this, the IRS has actually developed a new guide for their agents regarding cash-intensive businesses. It’s crucial to be meticulous with your documentation and reporting to avoid scrutiny.

You have crypto transactions or foreign bank accounts.

Recently, the IRS has been focusing on taxpayers who engage in crypto transactions to ensure accurate reporting and prevention of potential underreporting. In addition, taxpayers that fail to report foreign bank accounts or income from foreign sources can also lead to potential audits. 

How will you be notified of an IRS audit?

The IRS will only notify you of an audit via mail. You will never be notified of an audit over the phone.  

What should you do if the IRS audits your return?

You may be feeling overwhelmed if you receive an IRS audit notice. Fortunately, you can work with the IRS to prove the information on your tax return was accurate. Here’s what you should do if the IRS audits your tax return.

1. Review any information and requests from the IRS

If you receive an IRS audit notice via mail, the notice may request supporting documentation. In that case, simply provide the supporting documents the IRS asks for within the specified time period, which is typically 30 days. Once you submit your documentation, the IRS will use those documents to confirm your tax return is accurate.

Here’s a list of some of the records you may need to provide during an IRS audit:

• Receipts
• Bills
• Canceled checks
• Legal papers
• Loan agreements
• Logs or diaries
• Tickets
• Medical and dental records
• Theft or loss documents
• Employment documents
• Schedule K-1

Office and field audits are more involved. If you’re going through an office or field audit, you’ll have to provide supporting documents and answer in-depth questions about your finances and your business with an IRS agent. For these types of audits, you may want to consider working with a tax attorney or CPA who can represent you and act as your advocate during the audit process.

2. Organize requested information

Once you know what information the IRS is looking for, you can collect and organize any supporting documents. Gather your supporting documents and be prepared to explain any items the IRS has questions about.

For office and field audits, gather as much information as you can and be prepared to answer a long list of questions. The IRS may ask you about bank deposits, sources of income, and other business activities throughout the year.

If you don’t have the documents you need for an IRS tax audit, you may be able to use other records or the statement of a third party to supplement lost records.

3. Respond

Now that you’ve gathered your supporting documents and you’re ready to answer questions, you can respond to the IRS. If you were audited by mail, you can send the IRS these documents along with explanations about specific items that triggered an audit.

Based upon the information you provide, the IRS may adjust your tax return for misreported income, credits and deductions you don’t qualify for, as well as for math errors.

After you respond, the IRS will decide whether your tax return needs to be adjusted or accepted as is, and will then close the audit.

Can you appeal an IRS audit?

If you disagree with the results of your IRS audit, you typically have 30 days to appeal. You can request an appeal with the IRS Office of Appeals,

If you were audited by mail, the letter with the proposed adjustments to your tax return marks the start of the 30-day appeal period. Make sure you appeal within 30 days so you don’t lose your right to appeal.

Common tax audit myths debunked

IRS tax audits can be overwhelming, but they’re usually not as much of an ordeal as they’ve been made out to be. In this section, we’ll take a look at some of the most common tax audit myths and shed some light on the reality of tax audits.

Myth #1: The IRS is watching your every move.

In reality, the IRS has very little information about you other than what is reported to them each year through forms filed regarding your income, health insurance status, and some tax-deductible expenses like mortgage interest. The rest of their information comes to them when you file your tax return. Most audits are triggered by the matching process between what has been reported to them and what you report.

Myth #2: Certain tax deductions will trigger an audit.

Some taxpayers forgo valuable tax deductions, such as the expenses of operating a home office, because they are afraid that doing so would bring the IRS knocking on their door. There may have been some truth to that in the past, but these days so many taxpayers work from home on a regular basis, the IRS is realistic about its necessity. In fact, they developed the simplified home office deduction because so many eligible taxpayers avoided taking the deduction.

Myth #3: Every letter from the IRS is an audit.

Many taxpayers think every letter received from the IRS is an audit, but actually, not all correspondence received from the IRS is an audit. The IRS also sends a letter if you have a balance due, your refund changed, your identity needs to be verified, your return was corrected, if there is a delay in processing your return, or if there is a question about your return. 

Myth #4: If I make a mistake, I may go to jail if I reported something wrong. 

In truth, very few people go to jail unless they’ve committed extensive fraud. Typically, if you made a mistake, you will y see an adjustment made to your tax return, resulting in a balance due with fines and penalties. .

Myth #5: An audit will always cost you money.

This may shock you, but every year, many thousands of taxpayers walk out of an audit with the government owing them. Additionally, many audits end with the IRS finding that everything is just fine and there is no change in the taxes at all.

No matter what moves you made last year, TurboTax will make them count on your taxes. Whether you want to do your taxes yourself or have a TurboTax expert file for you, we’ll make sure you get every dollar you deserve and your biggest possible refund – guaranteed.