“IRS audit.” The words strike fear in the hearts of many taxpayers.
It’s valid to be concerned if you receive a notice of an IRS office or field audit.
After combing through your financial records, tax examiners may determine that you underpaid your taxes, which will leave you with a large tax bill.
While it’s rare, the IRS may even decide you were unlawfully and willfully withholding information about your income. If that happens, you could be charged with tax fraud. Charges of tax evasion typically begin with an IRS audit, but may escalate to criminal prosecution. Fortunately, it rarely gets this far. In 2023, the IRS initiated fewer than 3,000 criminal investigations for tax evasion.
Tax Audit Myths and Misconceptions
There are also a lot of misconceptions about the auditing process and results. People think an audit will reveal they owe the IRS thousands of additional tax dollars.
A small business owner may fear they will have to shutter their company following an audit. In fact, non-compliant businesses who underpay their taxes are only 2.7% to 12.6% more likely to survive than any other business, according to a report from the University of Texas at Austin.
Individuals and business owners, alike, believe an audit will be a time-consuming, expensive, and stressful process. But this isn’t always the case, especially if you seek professional help and have kept good financial records.
Additionally, it’s important to understand there are different types of audits with varying degrees of complexity.
The most common audit, a correspondence audit, could be as simple as replying to a letter from the IRS with additional documentation to support your claims.
Three Types of IRS Audits
Before we dive deeper into how to handle a correspondence audit to ensure you receive the tax refund you deserve, let’s look at the various types of audits.
Office Audit
An office audit takes place at an IRS office. You might need to bring paperwork and documentation showing your income, qualified tax deductions, and proof that you are eligible for certain tax credits. Before you have to schedule an office audit, you’ll receive a letter from the IRS. You can confirm the meeting time proposed or contact your IRS examiner to re-schedule. Be sure to take time to gather the appropriate records and documentation requested in the initial letter sent by the IRS.
Field Audit
In a field audit, the IRS examiner visits your office or place of business. This audit is extremely comprehensive. If you are a business owner, the examiner may want to review your profit and loss statements, business receipts, and other financial records. According to a former IRS agent interviewed by Debt.org, a field audit can take four to six weeks, on average, although some may drag on for a year or more.
Correspondence Audit
The simplest type of audit, a correspondence audit is conducted entirely by mail or through the electronic submission of documents. Typically, if your tax return is selected for a correspondence audit, you may have to show clarification about a few items on your tax return.
For instance, you may need to show proof that a child you claimed as a dependent actually lives with you and relies on you for support, per the IRS guidelines. You might need to show proof of charitable deductions. If you claimed the Earned Income Tax Credit, you might need to show proof that you qualified for the credit based on meeting minimum income requirements.
Audits: Big Business for the IRS
In the 2023 fiscal year, the IRS closed more than half a million audits to bring in an additional $31.9 billion in revenue for the federal government. Of those audits, the lion’s share of revenue came from field examinations, which brought in $24.1 billion. Correspondence audits brought in $7.8 billion. The remainder came from automated programs designed to ensure taxpayers were filing their tax returns and not underreporting income, according to statistics from IRS.gov.
Higher income taxpayers with total positive income of $1 million or more are audited the most frequently. In 2019 (the most recent year for which the IRS has provided statistics), individuals with $10 million or more in reported income had an audit rate of 11%. Those with $5 to $10 million had a 3.1% audit rate, and those with income from $1 million to $5 million had an audit rate of 1.6%.
Reasons for a Correspondence Audit
The IRS may request a correspondence audit for any number of reasons. Here are some of the most common:
Underreported Income
If you are a 1099 contractor with multiple sources of income, it’s easy to forget to claim some of that income. Maybe your client filed a 1099 with the IRS but you never received it. Maybe it arrived via email and went into a junk mail folder. Or maybe the 1099 got lost in a stack of mail.
That’s why it’s important to track your income as an independent contractor, but errors happen. If the income you claim as a self-employed taxpayer doesn’t match the income reported by your clients on 1099 forms, the IRS will reach out in the form of a correspondence audit for clarification.
American Opportunity Credit
If you claimed the American Opportunity Credit (AOTC) for yourself or a household member who is attending college, the IRS may request additional documentation to prove your household qualifies for the credit. If you claimed AOTC, make sure the IRS received Form 1098-T, Tuition Statement, with your tax return. If you didn’t receive this form from the educational institution, you may need to request a copy. The IRS website says the agency will also accept canceled checks or receipts for fees, books, and supplies.
Dependents
Likewise, the IRS may need to show proof of residency and proof of the child’s age if you claim a child as a dependent or filed for the Child Tax Credit or Additional Child Tax Credit. First, make sure your dependent qualifies for the credit, and then make sure to share supporting documentation with the IRS to receive the funds you are owed.
Filing Status
The IRS may send Form CP-75 or CP-75a to verify your filing status if you claimed the EITC. If you are married and lived with your spouse for six months during the tax year in question, you can’t claim the EITC as “married, filing separately.” You may need to show proof of residency or proof of a legal separation to claim the credit as head-of-household or married, filing separately.
EITC Audits: A Common Form of Correspondence Audit
As you can see, there are many reasons the IRS may pursue a correspondence audit. One of the most common is to determine if a taxpayer wrongfully claimed the Earned Income Tax Credit (EITC). The rules for claiming the EITC are complicated, even for tax professionals. According to the Taxpayer Advocate Service, 55% of returns claiming the EITC that were selected for audit in 2022 were prepared by tax experts.
Across the board in 2022, taxpayers had a 0.23% chance of an audit, according to statistics from the Transactional Records Access Clearinghouse (TRAC). Filers who claim the Earned Income Tax Credit get audited 5.5 times more often than the national average, according to the Bipartisan Policy Center.
The bulk of EITC audits are correspondence audits, but many individuals panic upon seeing an audit letter from the IRS and don’t know the best steps to take. Of the EITC audits closed in 2022, 38% received no response from the taxpayers. Another 25% were closed as “taxpayer default,” which means the IRS adjusted the return to remove the EITC credit because the taxpayers failed to take action after receiving a determination from the IRS. They didn’t pay the additional tax owed and they failed to file an appeal with the U.S. Tax Court within 90 days.
Facing a Correspondence Audit? Here Are The Next Steps to Take
Whether you’re facing an audit for your EITC claim or any other reason, you want to take action within 30 days of receiving the letter. There is a toll-free audit assistance phone line for calling the IRS, or you can respond to the IRS by mailing the documentation to the address provided on your audit letter.
As with so many matters related to tax collections, the worst thing you can do is to ignore any letters or notices and hope the situation will work out. Any action, whether that’s to make a payment, negotiate an installment agreement, or speak to a tax professional, is better than doing nothing.
If you’re faced with a correspondence audit for any reason, it’s best to provide the IRS with the information the agency has requested within 30 days. If you aren’t sure what documentation to provide speak with a tax professional for clarification.
The experts at Alleviate Tax are always standing by ready to assist taxpayers facing unresolved tax debt.
PPA
What is the IRS correspondence examination?
The IRS correspondence examination is another term for an IRS correspondence audit. The IRS sends a letter requesting additional information or clarification regarding information on your tax return. For instance, if you itemized deductions and deducted 20% of your income for charitable contributions, the IRS may ask for receipts as proof. If you claimed the Earned Income Tax Credit, the IRS may seek proof of the dependents living in your household.
What are the three types of IRS audits?
The IRS divides audits into three categories: correspondence audits, sometimes called mail audits, office audits, which take place in an IRS audit, and field audits, which take place in the taxpayer’s home or place of business.
How long does a correspondence audit take?
An IRS correspondence audit can take less than a month or it can take five or six months or longer if you petition the U.S. Tax Court for an appeal. You have 30 days to respond to your initial audit letter, and 90 days to file an appeal after receiving a response from the IRS. If the findings of an audit show the IRS owes you a refund, you should receive the funds within six to eight weeks.
What is the difference between correspondence audit and office audit?
An office audit takes place in an IRS examiner’s office, while a correspondence audit takes place by mail only. A correspondence audit is less involved and extensive, and may only require you to show proof of one or two tax deductions or credits you claimed.
