How Income Tax Audits Work

Preparing for Income Tax Audits

Mary Kersey transcribes data from tax returns at the Cincinnati Internal Revenue Service Center on April 8, 2005, in Covington, Kentucky.
Mary Kersey transcribes data from tax returns at the Cincinnati Internal Revenue Service Center on April 8, 2005, in Covington, Kentucky.
Mike Simons/Getty Images

How do you prepare for an income tax audit? It depends on the type: correspondence, field or office.

Correspondence Audit

If the IRS examines one of your returns, the examination will likely take place via mail. The IRS uses correspondence audits to take care of the most common tax return problems, such as missing forms and schedules, illegible entries and mathematical errors.

Your first step is to return the audit notice along with any documentation and explanations the IRS has requested. Such documentation might include:

For example, if the IRS questions whether your business meal deductions are valid, you would include receipts from those meals, as well as any proof that these meals were, indeed, business related.

Field Audit

In a field audit, the examiner visits your home or business to verify the information on your tax return. For example, if you write off a massive amount of printer ink, a field examiner might want to know why you go through so much ink.

Office Audit

In an office audit, you go to an examiner's office. The examiner requires you or your representative -- such as your tax preparer or lawyer -- to bring documentation and information such as receipts, account statements or pay stubs.

At the end of the audit, the examiner will mail you or give you a 30-day letter. This letter consists of a copy of the examination report, an explanation of how the IRS wants to change your tax return to reflect the report's findings, an explanation of your right to appeal and a handy publication called "Your Appeal Rights and How To Prepare a Protest If You Don't Agree."

You have 30 days to respond, so if you're not sure about the IRS's findings and you want to consult a tax professional, don't rush to sign the examination report. If, within 30 days, you find the IRS is correct, indicate you agree and sign the examination report.

If you do not agree, however, you can appeal the findings before the 30 days is up. An appeal, handled by an IRS Appeals Officer, can take a year or longer.

Following the appeal, the IRS sends a 90-day letter, which gives you -- you guessed it -- 90 days to request an escalation to Tax Court, in case you don't agree with the Appeals Officer's findings. Most audits are resolved long before Tax Court comes into the picture.

But before you appeal the findings, it would be in your best interest to ensure that you are 100 percent right, because interest accrues on any unpaid tax from the day you file your return, not the date of your audit. For example, if the IRS audits you for a return you filed two years ago, and it turns out you are in the wrong, you owe the unpaid tax plus interest that has accrued over that two years plus late-payment penalties. As you might imagine, these combined factors can make for a nasty bill.

How do you steer clear of the audit behemoth? Read on.