Tax Audit

What is the IRS tax audit process?

 The IRS tax audit process is not something to be feared about if you’re honest. The IRS and State departments of taxation conduct audit to verify the accuracy of your tax returns. In some cases, they want to check the integrity of your return, and upon their review, you might be due for a refund.

How are tax returns selected for an audit?

There are computer programs that the IRS use to check the accuracy of your return. There are also methods not dependent on these computers. Let’s take a look at their methods for the IRS tax audit process:

The Discriminant Function System (DIF)

 Deductions and exemptions claimed may put a red flag on your tax return with this specialized computer program. You’ll be given a DIF score for the tax return you submit. Through a classified formula, the score is determined. This is one score you want to get a low mark because the higher it goes, the more likely you are to be audited.

The Unreported Income Discriminant Function (UIDIF)

 The main difference of this from the DIF system is it’s heavily focused on unreported income. The score is calculated on the individual’s income and expense ratio. Spending beyond your reported income will send a red flag to the IRS. But, if this can be verified through the filing of low-income years, then such an explanation would suffice.

The Information Returns Processing System (IRP)

Third parties (such as employers, banks, social security administration, etc.) who submit such tax information can be cross-checked to verify the accuracy of your tax return. In other words, if your employer says one thing and you file another number, then you are setting yourself up to be audited. Don’t assume you can get around this third-party verification system.

If incriminating documents are turned over to the IRS

Should the IRS come into the possession of evidence that shows intent for tax evasion, an audit becomes inevitable. The IRS just needs to check if the correct taxes were paid and identify those involved in tax avoidance scheme.

Audits of Related Entities

When the IRS conducts an audit for one entity, and it’s not syncing as it should with other returns of other entities, then that trail needs to be followed to explain the discrepancies.

Should you receive a letter notifying you that the IRS will conduct an audit, there are three examination methods  (as part of the IRS tax audit process) that they’ll probably follow:

  1. Correspondence Audit: This most common type of audit is where the IRS will request for certain documents that can be sent to them through mail.
  2. Field Audit: If your earnings are over one hundred thousand dollars, then the IRS will make a visit to your home, or place of business, or tax professional’s office to do the audit. It’s not that common for the IRS to conduct this.
  3. Office Audit: With this type of audit, you will be required to bring the requested documents and you will be meeting with a representative of the IRS to review your return thoroughly.

Once they’ve completed the IRS tax audit process, the IRS Form 4549 or the IRS examination report will present proposed changes to the tax liability. You can either agree or disagree with these findings.

Approval of Audit Findings

The copy of this report must be submitted with IRS Form 870, which is a Consent to Proposed Tax Adjustment. Putting your signature on this form means you agree with the tax deficiency, if any, and are willing to settle any penalties or interest accrued. A payment plan will be agreed upon should you be unable to pay the full amount and a monthly payment scheme will be determined.

Disapproval of Audit Findings

 You will have 30 days to submit additional documents for their consideration. This will give you an opportunity to further discuss your case with the examiner which may even lead to meeting with the group or senior manager. An appeal can be requested since you are in disagreement with the findings. Should you fail to do anything within 30 days, the IRS will deem this as a disagreement. Otherwise, if you don’t file for an appeal within, IRS will finalize will become final. 

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