"An IRS audit is a review/examination of an organization's or individual's accounts and financial information to ensure information is being reported correctly, according to the tax laws, to verify the amount of tax reported is accurate." –IRS.gov
If you receive an audit notice, your tax return failed to stay below the radar. Although, according to the IRS, some audits "are selected at random," it is far more likely that:
- Your return showed small income but unusually large deductions.
- Your deductions didn't logically match up with your profession.
- You claimed large auto, travel and entertainment expenses.
- Your return didn't match what was reported by your employer.
- Your business return continued to show consistent losses year after year, causing the IRS to wonder why you would stay in business if you weren't earning anything.
What happens next
You will receive a first notice of an IRS audit with specific instructions, and you should respond immediately. Quite often it is a simple matter of paying additional taxes or responding to a request for more information. In the latter case, it is important that you have all your financial records organized and gather up copies for either a mail or audit in person at a local IRS office -- or possibly at your place of business/at home.
How you come out of the audit depends on whether you honestly reported your income, if your deductions and credits comply with the tax code and -- most importantly -- you have the records to back up your return.
The worst thing you can do
The best advice is this: don't ignore the IRS notice. Depending on the gravity of the situation, the IRS could take drastic measures to collect on what they determine you owe. Their power is vast and they can freeze your bank account, attach your wages, put liens on your property or even drag you to court to face criminal charges.
Settling your tax debt
If you disputed the audit and lost your appeals, your only recourse is to pay up or go for IRS debt forgiveness, or tax settlement. A tax settlement essentially allows you to settle your tax debt for an amount less than originally owed. Usually, extenuating circumstances exist and the taxpayer simply cannot pay off the debt in full.
How it works
You could either negotiate a settlement to pay less than the total tax bill or agree to another method that might include time payments. Whatever arrangement arises from the negotiation, the principal benefits have to do with avoiding penalties and other sanctions arising from the IRS's debt collection powers:
- Pay less: You could end up paying a substantially lower tax bill, if you meet certain criteria. Caution: According to IRS rules, most taxpayers are not eligible for a reduced payment. To find out if you qualify for an "Offer in Compromise," check out the IRS on line pre-qualifier questionnaire.
- Avoiding IRS Sanctions: Cooperating with the IRS in a tax settlement arrangement prevents all those previously mentioned IRS draconian measures while you begin bargaining in good faith to settle your tax problems.
Don't face the IRS alone
Our tax code is complex and grows even more so each year. IRS auditors know this and use their knowledge to full advantage in doing their job, which is to bring in tax dollars. That's what they do, and you might be tempted to simply accept an auditor's "wisdom" and give up without a fight.
On the other hand, if your return is complex or you believe the tax auditor is being unjust, hiring an experienced tax professional can:
- Help you assess whether the auditor is wrong.
- Assist in preparing a strategy based on a thorough knowledge of the tax code.
- Find missed deductions or credits that could reduce your liability.
- Provide someone qualified to speak on your behalf during audit proceedings.
Final word of advice
Be aware of your vulnerability to an IRS audit. If your income is high, your chances of being audited rise. In any case, keep good records -- at least three years of financial files. If you receive an audit notice, read it carefully and fully comply with what the IRS requires. If you feel overwhelmed or intimidated, don't panic. There's help out there. The IRS is powerful, but you have rights.