Unit
- Audit triggers: Tax authorities select returns for examination using statistical scoring, random selection, and targeted criteria such as large deductions, unusual credits, or noncompliance patterns. High-income taxpayers, business owners, and those with foreign accounts face elevated risk.
- Correspondence audits: The least intrusive type, conducted by mail, focusing on specific items like a missing form or a questionable deduction. The taxpayer responds with documentation within a set timeframe, often resolving without a field visit.
- Office audits: Require the taxpayer to appear at a tax authority office with records. These audits typically examine more complex issues such as business expenses, rental income, or childcare credits, and may involve multiple tax years.
- Field audits: The most comprehensive, conducted at the taxpayer's home, business, or accountant's office. Agents review books, interview staff, and inspect physical assets. These audits cover entire returns and can last weeks or months.
- Industry-specific targeting: Tax authorities often focus on high-risk sectors such as cash-intensive businesses, real estate, construction, and gig economy workers. Understanding your industry's audit profile helps prioritize defense efforts.
- Statute of limitations: The IRS generally has three years from the filing date to assess additional tax, but this extends to six years for substantial understatements and indefinitely for fraud or nonfiling. Practitioners must track these deadlines.
- Regulatory framework: In the US, the Internal Revenue Code (IRC) governs audits and appeals, with procedural rules in the Tax Court. International standards like OECD guidelines influence cross-border audits.
- Penalty exposure: Common penalties include accuracy-related penalties (20% of underpayment), fraud penalties (75%), and failure-to-file penalties (5% per month). Proactive defense can reduce or abate these.
- Representation options: Taxpayers may represent themselves, or engage a CPA, enrolled agent, or tax attorney. Each credential offers different levels of privilege and advocacy rights, with attorneys providing the broadest protections under attorney-client privilege.
- Appeals process: After an audit, taxpayers can request a conference with the IRS Office of Appeals, an independent body that mediates disputes without litigation. Filing a protest within 30 days preserves the right to appeal unfavorable findings.
- Documentation strategy: Maintaining organized records for at least three years is critical. Taxpayers should retain receipts, bank statements, contracts, and mileage logs. Well-prepared documentation often shortens audit duration and reduces adjustments.
Regulatory Requirement
Regulation: IRC Section 7602
Authorizes the IRS to examine books, records, and witnesses to determine tax liability. Taxpayers must comply with reasonable requests, but can assert privileges such as attorney-client and tax practitioner-client under IRC Section 7525.
Quick Revision
- Tax audits are triggered by random selection, scoring algorithms, and targeted criteria like large deductions or noncompliance.
- Three main audit types exist: correspondence (mail), office (in-person at IRS), and field (on-site).
- Industry-specific targeting focuses on cash-intensive businesses and high-risk sectors.
- Statute of limitations is typically three years, extended for substantial understatements or fraud.