The word "audit" can make anyone break out in a sweat, but a little understanding about what it is and how the Internal Revenue Service (IRS) works may make you more comfortable. Some audits are no big deal; some can be onerous. Once you identify the type of tax audit that’s being conducted, you'll know—or at least have a better sense of—what’s involved. So dry your brow, and let's begin.

Key Takeaways

  • Understanding the different types of IRS audits can help you handle them.
  • A correspondence audit is handled through letters. The simplest type just says you owe more funds. A more serious type asks for documents, usually to support a deduction.
  • In an office audit, the IRS asks to interview you in person regarding specific items on your return.
  • In a field audit, an IRS agent comes to your home, your place of business if you’re the owner, or your accountant’s office to do a general examination of your records.

Correspondence Audits

As the name implies, correspondence audits are handled through written correspondence—the mail.

The Simple Letter

The first type of correspondence is a simple letter sent to you by the IRS to claim you owe the government money. While this missive is not technically an audit, the failure to resolve it may cause the initial matter to devolve into one.

A simple letter from the IRS can result from:

  • A math error on your part on your tax return (for example, you meant to report $2,500 in income but only reported $500, so you owe taxes on the omitted $2,000).
  • An omission of income on your tax return that’s been reported to the IRS on another form (e.g., your W-2 form, a 1099 for certain investments or independent contractor wages, or a Schedule K-1 for an interest in a partnership, S corporation, trust, or estate).

If you get such a letter, you can agree that the fault was yours and pay the bill (taxes, interest, and, in some cases, penalties), something you can decide yourself if the mistake is obvious and wholly yours. Or you can disagree and proceed to further examination of the specific items in contention (which may continue to be handled by correspondence or on the telephone). You may want to bring in a tax professional if you don’t feel comfortable arguing your position (e.g., the IRS says you didn’t include income on your return that you, and your preparer, believe is not taxable).

The Audit Letter

The second type of letter you may get from the IRS is one asking for certain documents to support a deduction or other position taken on your return. This a real, albeit small, audit: a correspondence audit. Maybe the IRS wants to see a written acknowledgment from a charity for a donation you made and deducted; maybe you need to supply a canceled check or credit card receipt for another deductible expense. Mailing in the requested proof can easily resolve the issue.

If you don’t have the proof, you may want to pay up in order to close the matter (e.g., the amount involved is minimal and you believe your time is better spent in other pursuits). You can continue to argue your point through IRS channels (all of which will be spelled out in further correspondence from the IRS), and ultimately litigate (if the issue is significant enough to justify your time and the cost of a professional if you choose to have representation).

Note: If you paid a pro (a CPA or other accountant) to prepare your return, they can deal with all this as your representative, but may charge by the hour for this service. If you used tax return preparation software, you may have audit representation if the program gave it to you or you bought it.

Office Audit

The IRS may want to interview you in person regarding specific items on your return.  This is a full-fledged audit and a step-up in seriousness. You’ll receive a letter asking you to come to a designated IRS office on a particular date (the appointment can be rescheduled for your convenience, as long as the IRS agrees). You can bring a CPA or other tax professional for representation, which may be a good idea to make sure your actions won’t expand the IRS’s inquiries beyond those specified in the audit letter.

An audit may result in no change to your return, or a finding that you owe taxes, or even a finding that the IRS owes you a refund. An unfavorable initial determination by the IRS agent you meet with is not necessarily final. You have a right to appeal it and, if still not satisfied, go to court.

Field Audit

This is an audit where an IRS agent comes to your home, your place of business if you’re the owner or your accountant’s office.  This audit is more intrusive, literally (because of the presence of the agent on your turf) and technically (because the audit is not limited to specific items). While such audits for individuals are very rare, if you are selected for this type of audit it’s advisable that you are not alone; have a tax pro (like an attorney) by your side.

Line-by-Line Audits

These are the most dreaded audits of all. Taxpayers are chosen at random to have every line on their return examined. These audits only occur once in a great while under the National Research Program (NRP).  They are conducted to give the IRS data used to conduct future targeted audits, but taxpayers who go through them may owe additional taxes, interest, and penalties.

The Bottom Line

IRS audit statistics show that your chances of being audited are slim (just over half of 1%—only 0.59%—of individual returns were audited in 2018), although the risk is higher for those with income over $100,000. Overall, audits are down 10% from 2017, and IRS budget and personnel constraints make it likely that the chances of being audited are only going to be lower in the near future. Still, if you should find yourself under an audit, know how they work and your rights in the process, which are delineated in detail in IRS Publication 556.