What you need to know about how tax returns are selected by the IRS for examination, the IRS examination process, taxpayer rights related to the examination, and audit resolutions.
In general, an audit is an examination of a taxpayer’s accounts and financial information performed to evaluate the accuracy of the tax being reported.
The IRS employs three methods to select returns for examination; matching, related examinations, and statistical formulas.
- Various documents used in the preparation of an individual or organizations tax returns, such as W-2’s and 1099’s, are provided to the IRS as well as the taxpayer. While processing returns, the IRS will attempt to match the tax documents they received to information reported on a tax return. Any discrepancy may lead to a return being selected for examination.
- Returns may also be selected for examination if they involve issues or transactions with other taxpayers whose returns have been selected for examination.
- Finally, the IRS also utilizes a computer program, Discriminant Inventory Function System, which assigns a numeric score to both individual and corporate tax returns as they are processed. The higher the score assigned, the more likely that an audit would result in a proposed change and therefore the more likely the return will be selected for audit.
A taxpayer will usually be notified that a return has been selected for audit by mail. The audit may be conducted entirely by mail or by way of a field audit which involves an in-person interview conducted by an agent for the IRS at either the taxpayer’s residence, place of business, or personal representatives’ office. The IRS will provide the taxpayer a written request for documents that will be reviewed during the audit. The law requires taxpayers to retain records used in the preparation of a return for three years from the date a return is filed.
A taxpayer is entitled certain rights throughout the audit process such as the right to privacy about tax matters, a right to representation by an authorized representative such as a certified public accountant or an attorney, the right to know why information is being requested, how it will be used, and the consequences for not providing it, and the right to appeal disagreements with audit findings either within the IRS or before the courts.
Audits will conclude in one of three ways; no change, proposed changes agreed to by the tax payer, or proposed changes that the taxpayer disagrees with. The IRS may conclude after its examination of the records obtained, that the taxpayer has substantiated all items under review and issue a no change opinion. If, as a result of the examination, the IRS concludes that the records provided have not substantiated all items under review, they will propose changes to the tax return. If the taxpayer agrees with the proposed changes, they will sign documentation to that effect and pay any additional tax along with any interest and penalties assessed. If the taxpayer disagrees with the proposed changes there exist appeals processes that allow the taxpayer to pursue the issues further either within the IRS or within the court system.
Written by Tom Charbonnier