Anyone with a pulse will feel a sense of panic when they get that letter from the IRS requesting to show up at their house or place of business for an audit.
For most folks, the chances of an audit are low. According to 2013 Data Book, the IRS examined about 0.96 percent of all individual tax returns filed in 2012. Depending on the amount of adjusted gross income (AGI) reported, the percentage of tax returns examined varied. For example, 0.58 percent were examined for tax returns where AGI was at least $75,000 but under $100,000.
But the chances of an IRS audit increase substantially, depending on the amount of income, types of income, amount of deductions, the income earning activities and changes you have made since your last tax return was filed. For example, of the taxpayers who reported AGI between $200,000 and $500,000, 2.06 percent had their returns examined. And the IRS examined a whopping 9 percent of returns from those who reported income of at least $1 million but under $5 million.
The statute of limitations the IRS uses for examining returns is three years after the due date of the return or when it was filed. For substantial errors, the IRS can go back six years, thus the recommendation to keep most tax records at least that long. So, if an audit is going to happen, you'll get the notice two to three years after the return was filed.
What should you do if the IRS contacts you for an audit? Don't panic. Here are a few important things to think about, before you respond.
You can choose to attend and handle the audit by yourself, hire a tax professional to go with you or hire a tax pro go in your place. If choose to handle the audit yourself or to have a representative go with you, you increase the risk that the agent/auditor will ask questions that you would prefer not to have to answer on the spot.
Always keep in mind that the idle chit chat you share with the auditors helps them, not you. Each question has a purpose, and that purpose is to get information that can help them determine if you have underreported your income or overstated your expenses. Remember, they're professionals at this game, and you aren't. For this reason alone, it's always suggested to hire a tax pro to represent you at the audit and not attend, unless absolutely necessary.
If you choose to handle the audit yourself or go with a representative, here are some basic rules to follow.
- Be organized: Gather all the records you used to prepare the tax return(s) being audited.
- Don't overdeliver: Provide only the documents needed to support the deduction being questioned. Never give the auditor more or less information than is requested.
- Answer the question: Provide succinct answers to only the questions asked, and always answer questions honestly, but briefly.
- Keep originals: Never give the auditor the only copy of a document. Also, don't leave your original records with the IRS.
- Don't make friends: Don't chatter or exchange casual conversation. Each comment only gives the auditor more information about you.
- Keep your cool: Stay calm, don't be argumentative, stubborn or belligerent.
If you hire a tax pro to represent you, wait until your he or she has time to review any document before you sign it. Always insist on getting copies of information in the auditor's files or copies of anything that you sign.