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What Does IRS Audit Envelope Look Like

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 7 minute read

Auditors from the Internal Revenue Service have a bad rep for being feared amoral money-grubbing mercenaries who carry about terrifying calculators.

An audit by the Internal Revenue Service (IRS) might, in fact, reveal inaccuracies on your tax returns that could end up costing you money. Furthermore, interacting with the Internal Revenue Service during an audit is sure to consume time that could be better spent on, well, anything else. However, you should only be concerned if you have knowingly lied on your tax returns or committed tax evasion fraud.

It is still possible to be audited by the IRS at some point in your life, either at random or because your tax return raises specific red flags.

Generally, the IRS has three years from the later of when you file or when your return is due to conduct an audit, but if your taxable income is understated by more than 25%, the IRS has up to six years to conduct an audit. In cases when a taxpayer either fails to file a return or files a false one, the IRS may conduct an audit at any time.

The good news is that each year only a tiny fraction of taxpayers face an audit by the IRS. The Internal Revenue Service reportedly audited little more than 771,000 tax returns out of a total of 199 million filings submitted in 2018. That’s a negligible percentage of tax returns, accounting for just 0.04% of submissions.

However, there are a few things you need to know if you are ever one of the unhappy few who must go through an IRS tax audit.

IRS Tax Audit Types

Correspondence audits, office audits, and field audits are the three main categories of IRS audits.

  1. Audit of Correspondence

In most cases, the IRS will conduct a routine audit through mail. More than two-thirds of the 771,000 audited tax returns in 2019 were conducted through mail.

The IRS may request further information and evidence to verify your claimed income, spending, tax deductions, and credits in the form of a correspondence audit letter.

Most IRS audits begin with Letter 566. The Internal Revenue Service has sent you a letter asking you to clarify some details of your tax return by a certain date.

If you don’t respond to the initial letter from the IRS with the needed information or ask for an extension, the agency will issue a second letter detailing the proposed modifications to your tax return.

When information on your return doesn’t match what the IRS has on file, they may initiate a correspondence audit.

Let’s imagine you itemized your deductions and claimed mortgage interest, but the IRS never received the Form 1098 from your mortgage lender. In most cases, just mailing a copy of your form or writing a note describing the situation can resolve these tax concerns.

Sometimes the Internal Revenue Service will notify you that they received your tax return after the April 15 (or July 15 for 2019 returns) deadline but before the extension was filed. The IRS will cancel the penalty and terminate the matter if you can prove you mailed your tax return by the deadline via certified mail.

It’s true that taxpayers occasionally make mistakes. If the Internal Revenue Service (IRS) finds that you owe more money in taxes or penalties than you originally reported, you have the option of paying the extra money or appealing the IRS’s decision.

You should probably just pay the tax bill if you don’t think you have a reasonable chance of proving your case, especially if the sum is little. Interest and penalties on overdue tax payments accumulate exponentially.

If you lose your case, you’ll have to pay the extra tax as well as any interest or underpayment penalties that accumulated during the time you were appealing the assessment.

  1. Office Audit

If you receive a letter from the IRS requesting documentation for an audit, you will need to gather the items on the list and bring them to your local IRS office so that an examiner may review them with you in person.

The IRS often utilizes this kind of auditing for those who are self-employed, own small enterprises, or have more significant problems with their tax returns.

Since personal spending, inflated deductions, and fictitious employment of relatives who don’t actually work are common ways for individuals to avoid paying their fair share of taxes, the IRS is more likely to audit the tax returns of small businesses than those of individuals. 

The Internal Revenue Service has recently said that it intends to increase audits of small firms by a factor of 50% in 2021.

Gather the needed information and appear at the scheduled time if you are confident that you have sufficient documentation to support the claimed income, deductions, and credits on your tax return. The IRS will typically schedule your appointment at a time and date chosen at random. Contact the auditor assigned to your audit if the scheduled appointment time is inconvenient or if you need extra time to compile the necessary records.

  1. Field Audit

An IRS revenue agent, or occasionally many agents, may visit your home or place of business to conduct a field audit, during which they will examine your records and ask you questions about your operation.

It is increasingly customary for firms to undergo a field audit. However, the IRS may also choose to conduct a field audit of specific individuals, particularly if they have grounds to suspect that such persons have grossly underreported their income or otherwise violated tax rules.

If a revenue agent pays you a visit at your home or place of work, they can evaluate how your spending habits relate to the income you’ve been declaring on your tax returns. During a field audit, you have the option of having the meeting take place at the office of your tax preparer, accountant, or attorney.

In fact, hiring a professional tax preparer to defend you during a field audit is a smart move even if you didn’t collaborate with one to create your tax return. In most cases, they have dealt with IRS agents and auditors before and may offer advice on how to handle the issue and what questions to ask so that you don’t make things worse.

You will get written notice of the field audit, but the IRS revenue agent may contact you by phone to schedule the audit and go over the documents they plan to review.

Help with Tax Audits

To properly handle an IRS audit, it is not enough to just know the several types of audits that may be conducted. You may increase your chances of success by doing a number of additional things.

Get Expert Assistance

If the Internal Revenue Service discovers your error, you will likely be required to pay more in taxes. However, if you find that you are eligible for further credits or deductions, the IRS will send you a refund check.

As such, it’s crucial that you collaborate with the agent and keep an eye out for any discrepancies. Furthermore, several of the tax software packages available online, like H&R Block, include audit protection. If you utilize tax preparation software, contact the company for assistance.

Maintain Your Organization

Keep all of your tax paperwork, including receipts, in clearly labeled files throughout the year. If you’re well prepared for an IRS audit, the examiner is more likely to rule in your favor. Avoid losing important documents in the event of a fire or other calamity by storing them in a fireproof safe or backing them up to the cloud.

Ignore IRS Notices at Your Peril

Do not ignore the IRS in the hopes that they will go away. To put it simply, no. If you feel uncomfortable handling an IRS audit on your own, it is recommended that you seek expert assistance. Although hiring a professional will cost money, many find the assurance that comes from not having to worry about how to respond to the examiner’s questions and requests for further information to be well worth the investment.

Object to the Decision (if Necessary)

After the audit is complete, the auditor will provide you a report stating what they found and how much they think you owe in back taxes and penalties, if anything.

You can either sign off on their findings and conclusions in the examination report, or you can file an appeal with the IRS and perhaps have your case considered in tax court. If you need assistance determining whether an approach is appropriate, your accountant or legal counsel can provide insight.

Professionalism is required.

Maintain a positive relationship with the auditor whether you hire an expert or handle things on your own.

You should definitely inquire and defend your rightful deductions and tax return positions, but remember that auditors have discretion to waive or reduce fines. Assuming you treat your auditor with integrity, fairness, and professionalism, they will do the same for you.

Bottom Line

It’s nerve-wracking to face an Internal Revenue Service investigation. If you’ve been honest with the IRS and kept meticulous records, you won’t have to worry about being accused of fraud or spending time in federal jail. Everything will work out if you just work together and bring the necessary paperwork.

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