What Is a Tax Audit?

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A tax audit is a formal review of your tax return by the IRS. The IRS or your state's tax authority may request an audit to ensure you've adhered to tax laws and calculated your taxes correctly. They'll typically ask for additional documentation to support your claimed income, accounts, deductions and other information as part of the audit.

Tax audits are rare, especially among middle- and low-income earners. IRS data shows that people who make under $500,000 per year have less than a 1% chance of being audited. But if you do find yourself on the receiving end of an audit letter, don't panic: It could be the result of a simple mistake that can easily be corrected. Still, it's important to know what to expect so you can save any necessary documentation.

How Tax Audits Work

If you're selected for an audit, the IRS will notify you by mail. Their letter will explain whether your audit will be conducted via mail or in person, with instructions on how to proceed.

The audit request will include additional information you must provide to verify tax return items such as expenses, income or itemized deductions. IRS audits typically include returns from the past three years. If they catch a substantial error, they may add additional years, usually going back no more than six years.

In cases where there are too many books or records to mail, the IRS allows you to request a face-to-face audit instead. In other cases, the IRS may request an in-person interview. This could be either an office audit, which takes place at an IRS office, or a field audit at your home, business or accountant's office. In addition to gathering documents, you may need to prepare in-depth answers about your financial activity. Your letter will contain instructions and contact information.

You can request an extension if you need more time to prepare for the audit. But if you outright ignore your audit letter, the IRS could make changes to your return and propose taxes and penalties, which you have 90 days to petition. If a taxpayer continues to ignore audits, the IRS can start collecting on the tax bill by seizing assets, including bank account funds, wages, Social Security benefits or even property such as a car or real estate.

When you do proceed with an audit, the IRS may conclude that you've proven your claims and make no changes. If they do propose changes, however, you can either agree or disagree. When you agree, you'll sign documentation and may have to pay additional taxes you owe. If you disagree, you can request to meet with an IRS manager, go through an IRS mediation or file an appeal. Keep in mind that the IRS may charge a penalty for submitting an inaccurate tax return on top of paying what you owe.

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Reasons Why the IRS May Audit You

Why would the IRS want a closer look at your tax return? While it's possible you were randomly selected, it's more likely you were flagged for an audit due to one of these common causes:

  • You didn't include all your income. Each year, the IRS receives copies of your W-2 and 1099 forms, which they automatically compare with your tax return. If their system catches a mismatch and you failed to report income—such as forgetting to include investment interest or capital gains, or leaving off side hustle money—it could trigger an audit.
  • You claimed tax credits. If you claimed federal tax credits, deductions or breaks, you may be audited, especially if you didn't include proper documentation or failed to meet requirements. In recent years, low-income earners who claim the earned income tax credit are being audited at nearly the same rates as the wealthiest 1% of Americans.
  • You made a math error. Millions of math errors happen on tax returns each year. Hiring a tax professional or using tax prep software can reduce problems, but it's still possible to miscalculate or enter something incorrectly. A small math error may not warrant a full audit—the IRS may first let you know you made a mistake and offer a way to resolve it. However, it could lead to an audit if other issues are spotted.
  • You reported questionable business deductions or losses. Owning a business makes tax returns more complicated. If your business's profit or loss on your Schedule C form seems unlikely compared with what others in your industry claim, it could be a red flag. The IRS is also more likely to audit if they see unusual business deductions, losses for many years in a row or unreported income.
  • You failed to report foreign accounts. If you have more than $50,000 in assets in a foreign bank account, the IRS requires you to report it.
  • You didn't mention your cryptocurrency. With its rise in popularity, the IRS has started paying closer attention to cryptocurrency. Even if you don't receive any tax forms, you are required to report digital assets as well as pay taxes on them.

These are only a few of the common IRS tax audit triggers. Other issues that can set off IRS alarm bells include using too many round numbers, having a high volume of cash transactions or failing to report early withdrawals from retirement accounts.

How to Prepare for a Tax Audit

If you're selected for a tax audit, carefully review the letter explaining why you've been selected and how to submit your documents. Pay attention to the deadline, which is often around 30 days, and request an extension if needed.

If it's a mail audit, you'll likely only be asked to provide proof of a few items on your return. Once you gather the paperwork, it's wise to also write a clear summary in response. If you're nervous about doing this on your own, or you want help preparing the documents and response, consult with a tax accountant.

For an in-person audit, you will also need to gather documents. Most taxpayers pay a professional to represent them and handle the process of an in-person audit, as it can be more complex.

Tax Audits Do Not Impact Credit

While a tax audit may seem intimidating, many audits can be resolved easily. Also, know that undergoing a tax audit does not impact your credit or show up on your credit report.

If you undergo an audit and find yourself facing a steep tax bill you can't pay, don't ignore it since this can lead to penalties or worse. Ask the IRS if you're eligible for a payment plan, and contact your lenders to ask if you can temporarily reduce bills to avoid missing payments.