The Internal Revenue Service conducts tax examinations or tax audits throughout the year. Getting a letter from the IRS about an examination scares most people. However, you can make an examination less stressful by preparing yourself and maintaining all the necessary documents to back up your case. While many tax examinations are not serious, you should consult a tax attorney or an accountant for advice after receiving a notice of examination from the IRS.
An Examination and Audit
An examination is the same thing as an audit. The IRS selects taxpayer returns for examination for a variety of reasons. For example, the IRS uses random sampling, information comparison and computerized screening to select returns for audits. The discriminant function system is a computerized system used by the IRS that scores individual tax returns. If your return has a high score, the IRS may choose to review your return. The IRS conducts tax examinations by mail, in the field or at a business. The nature of the audit will generally determine where the examination will take place.
What Happens During an Audit?
Your examination notice from the IRS will list the specific areas of your return subject to examination. In most cases, the IRS will look at your total reported income by examining your financial statements, bank deposits and other investments. A discrepancy between your total deposits and the income you reported can raise a red flag. The scrutiny of the examination depends on what the IRS discovers during the initial examination. The IRS has up to three years to determine if you made any mistake on your filed tax return. If, however, the amount of the mistake exceeds 25 percent of your income, the IRS has up to six years to examine your return. If you filed a fraudulent tax return or you did not file a return, there is no statute of limitations for the IRS to examine your return.
Agreed or Disagreed
The audit process will result in either an agreement or a disputed case. If the examining agent agrees with what you present during the audit, the IRS will accept your original return as filed. If the examining agent finds a discrepancy, you can also reach an agreement and pay the tax owed. If, however, there exists a disagreement, the IRS will take measures to reach an agreement before initiating litigation. IRS appeals officers try to mediate the best possible solution for both the taxpayers and the IRS. If the appeals officer cannot reach a settlement, the IRS will issue a statutory notice of deficiency that requires you to pay the disputed tax.
The penalties resulting from a tax examination will depend on how much you underpaid. Prison is the most serious penalty reserved for serious tax offenders that committed tax-related crimes. In most cases, you will have to pay interest due from the date you originally filed your return until the date you actually pay the tax. Additionally, the IRS commonly imposes monetary penalties based on the seriousness of the tax reporting error.
Brian Bass has written about accountancy-related topics and accounting trends for "Account Today." He works as a senior auditor specializing in manufacturing and financial services companies for one of the Big 5 accounting firms. Bass hold a master's degree in accounting from the University of Utah.