There are various factors that may lead to an IRS audit (e.g., 1099 matching, high Discriminant Inventory Function (DIF) score, whistleblower, etc.). The easy answer to avoiding an IRS audit is to report all items on the return properly and file all forms timely. Review all Forms 1099 that you receive to make sure the bank or other reporting party accurately reflects your income. That said, this alone may not be enough. Depending on the size of the business or the individual’s AGI, the IRS may end up auditing the taxpayer simply to ensure that everything matches up as reported. Over the last few years, there has been a decrease in IRS enforcement, generally; however, taxpayers should not read this as a chance to skirt the tax laws. Certain areas of the tax law have seen increased enforcement, including offshore accounts and employment taxes.
After you receive an audit notice, don’t panic. The IRS may simply want you to substantiate a deduction or provide further proof of income. At the same time, know that the IRS will not go away until they have received all the information they need to determine whether you reported all income, deductions, etc. properly. It’s advisable to contact a tax attorney or an accountant with experience in audits to review your matter and determine the scope of the audit and potential exposure (including civil and criminal penalties). Most individual exams are handled as “correspondence audits”, i.e., the IRS sends the taxpayer a letter requesting certain information and the taxpayer submits the information without ever meeting an agent face to face. After the IRS receives the requested information, the agent will determine whether to make an adjustment. If the taxpayer disagrees with the adjustment, they may then send the case to the IRS appeals.
For more on this topic don’t miss my NSA ConnectED webinar this Tuesday: Nuts and Bolts of an IRS Audit