IRS Audits: What Triggers It and What Happens

an older businessman reading an IRS audit letter

One of the biggest fears of many of my clients is the risk of a tax audit or examination by the IRS. While the actual chances of getting audited are exceptionally low, it is the last thing one wants to go through. 

If you are doing things correctly, then going through an audit is nothing to worry about. If you have done things incorrectly on a tax return either accidentally or intentionally, then you are very right to fear an IRS audit. 

The good news is that IRS audits have been way down in recent years due to budget cuts. In 2019 the IRS only audited 0.4% of individual tax returns. This is about 1 in every 160 returns that gets audited. Many people view this number in different ways. 

Some still see it as a chance to be audited and it keeps them not only filing a squeaky-clean tax return but it sometimes hinders people from taking advantage of some of the credits that they do qualify for in fear of an audit. Others see that as a low number and think it is worth the risk in the attempt to save some money. 

In today’s article, I will not only explain what an audit is, but I will break down the audit process for you.  After that, I will point out some examples of common errors that raise red flags with the IRS and put taxpayers into these audits. Hopefully, this information can help you avoid ever having to deal with this situation.

 

What Is an IRS Audit?

An IRS audit is a review or examination of an organization’s or individual’s accounts and financial information to ensure information is reported correctly according to the tax laws and to verify the reported amounts of tax are correct. In other words, the IRS is double-checking the information you put on your tax return. 

By law, the IRS generally has 3 years after the tax filing deadline to initiate an audit. If you leave out up to 25% of your income or more, they have 6 years. The IRS performs these audits to minimize the tax gap or the difference between what the IRS is owed and what the IRS receives.

 

How Do Taxpayers Get Selected For An Audit?

A tax return is selected for audit by several different methods. Sometimes returns are selected based solely on a statistical formula. The IRS compares your tax returns against norms for similar returns. They develop these “norms” from audits of a statistically valid random sample of returns as part of the National Research Program the IRS conducts. The IRS uses this program to update return selection. 

Another way is called related examinations. This is when your returns are selected because they involve issues or transactions with other taxpayers such as business partners or investors whose returns were selected for audit. The IRS uses a program called the Discriminant Function System. This is a computer software program that gives each tax return a score called the DIF Score. This score is a number that statistically determines the likelihood of the tax return being accurate. The higher the number assigned, the higher the chance to be audited. 

If selected by either of these methods, then an experienced auditor will review the return. They may accept it and move on or if the auditor notes something questionable, they will identify the items noted and forward the exam to an examining group.

 

What Is the Tax Audit Process Like?

At this point, the IRS will either mail you or contact you to set up an in-person interview to review your records. The interview may be at an IRS office (office audit) or at the taxpayer’s home, place of business, or accountant’s office (field audit). Remember, you will be contacted initially by mail. The IRS will provide all contact information and instructions in the letter you will receive.

If the IRS conducts your audit by mail, the letter will request additional information about certain items shown on the tax return such as income, expenses, and itemized deductions. They will provide you with a written request for the specific documents they need to see. Basically, they are giving you the opportunity to prove you had rights to put whatever they are disagreeing with on the return. 

If you can prove your side of it, then you can respond with the requested documentation. 

If you cannot, then you must respond by accepting the IRS’ changes. 

 

Why Did I Get Audited?

There are some key triggers that will raise red flags with the IRS. If your tax return has any of these make sure you have the proper documentation and information to support them if the IRS disagrees with them. In this section, I will lay out and explain some of these triggers so you understand them to help you avoid a possible audit.

Unreported Income

This is probably the easiest way to get yourself into an audit with the IRS. This can happen on accident by not receiving an income from or forgetting other incomes received other than your primary wages. This is why it is so important to keep good records of all income received throughout the year and to keep copies of all income forms received. 

When these income forms, W-2’s or 1099’s are sent to you by your employers or financial institutions that you have done business with they are also sent to the IRS. So if when your return goes through the system and the incomes do not match up with what has been reported to them, this will raise major red flags.

Self-Employment

With self-employment, there are a lot of red flags that can be triggered. With self-employment, most of the income received is reported to the IRS with a Form 1099. So, if your version of your income for the year does not match up with what is reported to the IRS then you may be dinged for underreporting of income. 

Another big benefit of being self-employed is being able to write off portions of that income due to expenses. This can be a benefit and a curse. The IRS does understand that it takes money to make money, but they also understand that people don’t work hard for little or nothing. These types of returns are highly auditable especially when large portions of the income are written off.

Charitable Donations

You can be eligible for deductions from your income if you donated to charity throughout the year. If somebody puts large charitable donations this will raise the red flags especially if they have low income themselves.

Math Errors & Using Neat Round Numbers

Do not make mistakes. If you accidentally do the math wrong or put an 8 instead of a zero you can be hit with fines. Also, when inputting expenses and deductions using round numbers can trigger the IRS to request proof.

Stock Trades & Cryptocurrency Sales

All of this income must be reported. With these transactions, the brokerage or financial institution will send a Form 1099 to the IRS. Right now, cryptocurrency is a hot-button issue. With this income, it is especially important that not only is it reported but also you show on a Schedule D your gains and losses. Forgetting to report information on a 1099-B or any big change in your capital gains income could lead to an audit.

High Income

Statistics show that the more money you make the more likely you will be audited. In 2019 people earning $200,000 to $1 million had an audit rate of less than 1% while people making over $1 million had a 2.4% audit rate.

Claiming the Earned Income Credit

Claiming the EIC is an automatic trigger for an audit. The IRS will make sure that you are entitled to claim the dependents and that the income that you are reporting is correct.

 

How to Avoid an IRS Audit

There is good reason to fear the possibility of an audit. Despite the fact that only a small percentage of people actually get audited by the IRS, that still amounts to a large number that has to go through this process every year. 

As I wrote earlier, do not let the fear of audit hinder you from taking advantage of deductions and credits that you have rights to. If you have done things right and you have the information to prove it then an audit is no problem. If you are doing things that you do not have rights to or cannot prove, then you are rolling the dice and will have to deal with the consequences if selected. 

As I always recommend when filing a more complex tax return and utilizing deductions and credits, it is always well worth hiring a true tax professional. While many call themselves a tax professional, you will want to be sure the person your hire is somebody with the correct education and licensing. 

Unfortunately, there are many tax preparers who may use certain strategies on your tax return to reduce your tax debt and/or maximize your refund but those strategies are also major tax audit triggers. If you hire an IRS Enrolled Agent or a CPA, both have a license and are regulated, so they have something to lose if they make a mistake. An Enrolled Agent will also put their name on the return, backing up their work.

 

IRS Revenue Officer: Who They Are and What They Do

IRS Revenue Officer on the way to visit a business

Dealing with an IRS Revenue Office can be a challenging and, sometimes, even nerve-racking experience, especially when one shows up at your business or house doorstep unannounced. However, most of the time, these feelings of anxiety and stress are misplaced.

This guide will shed some light on the details surrounding IRS Revenue Officers, what exactly they do, and what to do if one contacts you. We also dispel some common myths and share some handy tips and information so you can use the acquired knowledge to your best advantage. 

 

What Does an IRS Revenue Officer Do?

Often confused with an IRS Revenue Agent, an IRS Revenue Officer is responsible for collecting money (taxes). They are civil employees employed by the IRS Field Collection office and collect taxes by interviewing taxpayers and running asset checks. If they cannot make contact with a taxpayer, they will work with third parties to gather the information they need. 

The general powers of an IRS Revenue Officer include:

  • Finding liens against you.
  • Interviewing 3rd parties about you.
  • Summoning records.
  • Issuing levies. 
  • Commencing seizure proceedings against you without needing a court order (see notes below). 
  • Referring you to the IRS CID if required. 
  • Levying any receivable accounts, bank accounts, subpoena documents, wages, or retirement funds. 

Remember that an IRS Revenue Officer is assigned to specific cases, not just any tax-debt-related case. In the overwhelming majority of cases, an IRS Revenue Officer will visit you if:

(1) The tax issue is associated with your business.

(2) Your tax debt is from older tax years.

(3) Your tax debt exceeds $100,000. 

 

Things to Know:

  • IRS Revenue Officers (1) do NOT carry weapons, (2) can NOT investigate you criminally, and (3) have absolutely NO right/authority to arrest you. 
  • Their badge is usually a plastic lanyard as opposed to that of an IRS Criminal Investigation Divisions (CID) officer, which is golden. 
  • An IRS Revenue Officer has a limited ability when it comes to seizing a taxpayer’s home, thanks to the Revenue and Reform Act of 1998. 
  • Anybody with a 4-year degree (not necessarily with a financial-related background) can get a job as a Revenue Officer. Before one visits you, though, they undergo months of (initial) training, and then ongoing training. 

 

What’s the Difference Between an IRS Revenue Officer and a Revenue Agent?

As already mentioned before, an IRS Revenue Officer collects taxes. Interestingly, they are not graded based on the sums they collect rather than how quickly they close cases. Although this is not always in the taxpayer’s favor, there may be cases when a taxpayer and a Revenue Officer have common goals and aspirations – for the case to be over and done with. 

IRS Revenue Agents, on the other hand, are assigned a different task – that of auditing taxpayers. So, the person that will collect taxes from you is NOT the same individual as the one who performs the audit. 

How Things Work – The Drill

As soon as the IRS assesses the tax, you will be called to pay the due amount (i.e., withholdings and unpaid employee taxes for business owners). If you cannot pay, the IRS will send out several notices. Then, the IRS will make contact with you to identify who is to blame for the underpayment. In doing so (most of the time, at least) an IRS Revenue Officer will visit your business and seek to assess the TFRP (Trust Fund Recovery Penalty), which is another word for the taxes, against as many taxpayers as possible. 

Therefore, you can understand that it is not just you, the business owner, who is at risk for a TFRP assessment – it includes everybody else also managing the finances of the company. It is worth noting that many times, these assessments reveal employees embezzling money from the business.  

Note: Depending on the amount of due tax, your collection case may as well stay with the ACS (Automated Collections System). This also happens when a taxpayer owes money to the IRS. In this case, you may never see an IRS Revenue Officer coming your way. Instead, you will be sent notifications of past due balance. If these are ignored, the IRS will try to collect the owed money via wage garnishments, bank levies, and liens. 

 

What To Do If an IRS Revenue Officer Contacts You

Nine out of ten times, the IRS Revenue Officer will try to determine your ability to pay. That aside, though, they may even investigate you for a TFRP assessment that you have not paid (this usually happens when you have unpaid employee taxes). No matter the reason why an IRS Revenue Officer shows up at your business, we strongly recommend ensuring you get the best representation possible. This can come from an individual that is helping you with this tax matter. You may, however, need a more robust representation, such as a lawyer or tax attorney (many taxpayers seek legal advice before giving an IRS employee any testimony). 

Keep in mind that things are usually fairly serious, especially considering that the IRS has half the field officers they used to have ten years ago. So, there must be a very important reason why you were assigned an IRS Revenue Officer. And, don’t think even for a second that the IRS will take it easy on you. 

When a Revenue Officer visits you for the first time, they should identify themselves by showing their ID (remember, badge carriers are usually from the Criminal Investigation Department). If you are certain that you don’t have fraudsters in front of you, you can sit down with the Revenue Officer and hear the “collection alternative” (i.e., Offer in Compromise) they have to offer you. If you agree to the proposed terms (meaning, a reasonable agreement is presented to you), you put everything behind you. If not, refer to the next section for the appropriate course of action.

In any case, you may want to consult with your tax professional before the IRS Revenue Officer pays their visit. Experienced tax representatives can be of significant assistance to you as they will:

  • Help you figure out your options.
  • Come to the negotiation table with the IRS agent knowing what to do. 
  • Deal with your IRS Revenue Officer and get a better agreement for you (than you). 

Tips:

  • Be honest with your Revenue Officer. You don’t want to annoy them by doing things like incurring a lot of new liabilities or hiding your assets while dealing with them. Just work with them. 
  • Cooperating with an IRS Revenue Officer does NOT mean that you must push yourself into something without considering the “aftermath” and consulting a tax professional. 

 

What To Do If You’re Getting Nowhere With the Revenue Officer

If the IRS Revenue Officer is being unfair or things show that you two will not see eye to eye anytime soon, you could:

  • Speak with their Group Manager (but do not keep your hopes up that they will take your side).
  • Address the Territory Manager (a step above the Group Manager). In this case, ensure you can prove that the IRS Revenue Officer did not act correctly. Otherwise, it may get you into deeper waters. 
  • Wait until you receive a Notice of Federal Tax Lien, Notice of Levy, or a notice proposing a levy and request for a CDP (Collection Due Process) hearing. Then, you or your tax representative can negotiate a better deal with a settlement officer. This action also puts the brakes on the revenue officer, who can do nothing while you appeal. 

Note:

  • It is required by law an IRS Revenue Officer makes their first contact in person, so do not expect a heads-up phone call. 
  • An IRS Revenue Agent will most likely notify you that you are under examination by sending notices to you before a field agent schedules their visit to your business or home. 
  • If you are being visited by an IRS CID officer, call a tax attorney immediately. 
  • If an IRS Revenue Officer or field agent leaves a note or business card on your door, use the contact information on the card and have your representative (i.e., tax or law firm) get in touch with the Revenue Officer. You are either being assessed for (probably) an underpayment of employee withholding or have a tax debt. 

 

The Best Course of Action to Take with a Revenue Officer

Your best bet when an IRS Revenue Officer visits you is to hire a tax professional or tax attorney to help you with your tax issue. Unlike what many people think, this does NOT make you look “guilty” in the eyes of the IRS agent. In fact, most of the time, IRS Revenue Officers admit being glad the taxpayer hired a tax or legal representative because they, as government employees, are not allowed to give any advice (legal or otherwise) that could help resolve your case in an instance. Indeed, the best IRS Revenue Officers want you to be well taken care of and represented. 

But, even if an IRS agent tells you that it is a waste of money and time to hire representation (“You could use the money you pay the tax prep company to repay your taxes”), you definitely need somebody that is 100% on your side. No matter how great a guy an IRS Revenue Officer is, they are still far from being your advocates – their position does not give them such liberty. Nor can they offer tax-related or legal advice. Plus, you will most likely be visited by a government employee that enjoys mowing over taxpayers. It is always good to know that you can get some control back into your own hands with the help of tax experts or legal representation. Plus, you can likely save a great deal of money!

 

Finally, remember that…

IRS Revenue Officers and Agents are ordinary people like the rest of us. This means that they, too, have good and bad days. They also have a significant workload they are called to manage every single day. This can force them to make decisions and offer agreements that may not be of your best interest.

Without a doubt, though, having to handle the stress and anxiety that comes with back taxes and the presence of an IRS Revenue Officer at your premises can lead to even more trouble and problems. For that reason, it is best to ensure you have a tax professional to help you resolve your issue and have your rights as a taxpayer well protected. 

 

IRS Audits: What Cause Them and How to Handle Them

woman looking at tax bill

Round numbers, deduction overkill, and math mistakes can raise some red flags that may bring the IRS knocking on your door, wanting to double-check your numbers to ensure you don’t have any return-related discrepancies. Whether an IRS or state audit, there is no reason to worry, provided that you are telling nothing but the truth and that you aren’t trying to cheat the system.

However, an IRS audit may also be conducted if you feel that you are paying more than you owe. In any case, this guide will help you understand the fundamental reasons why you could get audited by the IRS, how to deal with an audit, and how to deal with it quickly and effectively. 

What Causes an IRS Audit?

The IRS audits taxpayers as a means to reduce the difference (aka tax gap) between what the IRS receives and the money it is owed. The IRS may conduct an audit if they suspect that the reported amount of tax is not correct, be it for an individual or business. Some other times, though, these audits are random. Below are seven primary concerns/red flags that could put you or your business under the IRS microscope. 

  1. Making math mistakes.  It is paramount that you or the person that files your taxes NEVER make a math error. An “oops, I wrote 8 instead of 3” or “I got distracted and forgot to include a zero” will not help you. Although to err is human, it will be best if you could avoid making one when it comes to filing your taxes. So, always double-check (triple-check if needed) to avoid the hefty fines later on. You can be assured that the IRS will not care the least bit if the mistake was accidental or innocent.
  1. Not reporting part of your income.  If for whatever reason, you decided to keep under wraps an activity of yours that made you money, such as a freelance job, then you are probably asking for trouble. You see, submitting your W-2 form and refraining from including your freelance income from your Form 1099 leads you absolutely nowhere. This is because the person to whom you did the freelance task has probably already sent a copy of your agreement to the IRS. So, the IRS knows about your income, whether you report it or not. It is just a matter of time to discover that you have withheld from reporting non-wage income. The same applies to interest and stock dividends as well.
  1. Reporting false donations.  Making a considerable contribution to charity can get you a significant tax deduction. Claiming too many charitable donations, though, without being able to produce the proper documentation, will put you at a tough spot for sure. The IRS WILL notice that you claim $15,000 in charitable deductions on your $35,000 salary.
  1. Reporting personal expenses as business expenses.  This applies to self-employed, who report too many losses on their Schedule C to hide income. And, if you don’t yet have a clear idea of what business expenses are deductible, you can check out the IRS Publication 535 page.
  1. Reporting too many business expenses.  Deducting too many expenses for purchases you made that are not necessary or ordinary to your business WILL raise some eyebrows at the IRS offices. Better stick to reporting purchases that are (1) appropriate for the business or trade and (2) accepted and common in the business or trade. If, for example, you are a lawyer and feel like painting your apartment, don’t claim paint and paintbrushes. Neither meets the requirements mentioned above.
  1. Claiming excessive home office deductions.  To be eligible for a home office deduction, it is crucial that you use part of your home regularly and exclusively for your business or trade. This means that you can give yourself deductions for home office expenses only if you have a designated section in your home that is strictly used for business purposes.
  1. Rounding up numbers.  Try to be as precise as possible when you make your calculations. Also, steer clear from making estimations and doing things like rounding to the nearest hundred.  A much better practice is to round to the nearest dollar instead. If all of the numbers you enter for expenses are even numbers, it will raise some eyebrows and may force the IRS to request some proof of those expenses.

Other surefire ways to attract an audit if you are a business owner is to try to claim more expenses than justified by filing a dubious expense claim while also reporting a loss. The IRS will probably notice this attempt to have a lower tax liability. 

What Are the Chances of Being Audited?

According to IRS statistics, people who report zero income (but occupy the higher tax brackets) get the most attention from the IRS. However, it should also be noted that in recent years IRS audits have decreased in number. This has to do with the smaller IRS workforce and declining budgets. This, of course, does not mean that receiving an audit letter is out of the question. 

That being said, most audits are conducted for people of income above $200,000, as well as those missing data on their return. The same applies to individuals or businesses whose returns are way above the average or normal, based on the IRS statistical data on the typical amounts for various income levels and professions. 

Another point to consider is that audits related to missing data and math errors are usually initiated by mail rather than in-person by an IRS agent. Our experience has shown that the average payment tied to correspondence audits is below $7,000. More complicated issues may require a field audit, which usually ends up with the taxpayer owing more money to the IRS (around $20,000). 

How to Handle an IRS Audit

The first thing to understand is that the IRS may conduct a field audit, an office audit, or a correspondence audit, based on the severity of the problem. The most thorough type of audit is the field audit, whereas the correspondence audits only require smaller things, such as clarification on a particular area of the tax return.   

In any case, it is paramount to handle the audit respectfully and carefully – always with the assistance of your tax professional, who will know what information should be withheld and what information should be released. If possible, allow your tax professionals to act as a buffer by having the field audit conducted at their offices. 

In the event you receive an audit letter, it is best to forward it to your tax professional, who will then take it from there and deal with the tax auditor(s). After all, they have experience in dealing with the IRS and audits. If though you decide to take matters into your own hands, it is highly probable that you will say something that might trigger the IRS to open up more areas of your return for inspection. 

Do take an audit seriously, without fretting or panicking, and remember that not all audits turn out adversely for the taxpayer. To help minimize any negative impact on your business, you should do the following: 

1. Organize your accounting records from the past 6-7 years with the assistance of your tax professional. This includes everything from leases, hard copies of tax-prep data, and accounting books to canceled checks, expenses, and bank statements. 

2. Only answer to the auditor’s question about your tax return in a clear and straightforward way (not making excuses). Do not volunteer any other information, though, or provide accounting records that have not been requested from you. 

3. Let your tax professional handle things for you. They know exactly what to do, what to say, what not to say, and why. 

4. Only provide copies, not the originals. There is a high likelihood that your original documents get misplaced or even lost if you hand them over to the agent. The IRS will take no responsibility for losing your documents during an audit because this is part of your obligations. For that reason, either give copies or ask the IRS agent to copy the originals and then give them back to you. 

5. Know your taxpayer rights, the law that is supporting the deductions you claim, and the audit process. Although it is advised to try to settle any differences you may have with the agent at the audit level, you could escalate things and ask for a conference with the IRS Appeals Division. Or you could simply hire an experienced tax professional to argue your case in a way that will bring the best results for you. Given how complex the tax code has become, having a qualified tax pro by your side is definitely worth their fee to help you. 

Are you facing an audit or want to act proactively and stay on the safe side? We have your back. Just give us a call or get in touch with us for a free tax consultation. Our team of qualified and experienced tax professionals will help you with your IRS audit, get out of an unpleasant situation and ensure that you never find yourself there again.