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By Ajoy Gonsalves
An IRS audit is a procedure that most taxpayers dread, yet it is essential to understand this process's scope and how it can potentially impact you. In this comprehensive guide, we will delve into this topic, shedding light on the ins and outs of IRS audits, the statute of limitations, factors triggering audits, and much more. Whether you are a novice to the world of Safety and Compliance or a seasoned manager, this guide will provide valuable insights and tips that can help you navigate the intricate landscape of IRS audits.
An IRS audit is essentially a review conducted by the Internal Revenue Service to validate the accuracy of a taxpayer's returns and accompanying financial information. The IRS's primary goal is to ensure that all taxpayers, be they individuals or organizations, comply with the tax laws and accurately report their income. However, the IRS's capacity to audit is not infinite. It is governed by a statutory timeframe, also known as a 'statute of limitations'.
The statute of limitations is a law that sets the maximum time after an event within which legal proceedings may be initiated. For tax audits, the IRS generally has three years to examine your tax returns once they are filed. This means if you filed your tax return on April 15, 2020, the IRS has until April 15, 2023, to decide if it wants to more closely scrutinize your return.
However, this statute is not set in stone. Certain exceptions allow the IRS to extend the audit window to six years, or even indefinitely. Let's explore these scenarios to gain a clearer understanding.
The IRS may extend the audit period to six years under specific circumstances. This usually occurs when the taxpayer has omitted a substantial amount of income from their tax returns. A 'substantial understatement of income' typically refers to the omission of more than 25% of the gross income. For instance, if you earned $200,000 but only reported $140,000, the IRS could audit your returns for up to six years, given that you omitted more than 25% of your income.
Another scenario where the six-year statute applies is when taxpayers overstate their tax basis. Let's consider an example. Suppose you sold a property for $3M, claiming that your basis (the original investment in the property) was $1.5M. If, in reality, your basis was only $500,000, you would have paid tax on a capital gain of $1.5M instead of the actual gain of $2.5M. In such cases, the IRS gets six years to audit.
There are two primary situations where the IRS has an unlimited timeframe to audit. The first is when a taxpayer fails to file a tax return. In this case, the statute of limitations does not commence until a return is filed, giving the IRS an indefinite period to audit.
The second situation arises when the IRS has evidence suggesting tax fraud. If a taxpayer is suspected of fraudulent activities, the IRS can go back as far as necessary to investigate the matter. In essence, tax fraud opens up an unlimited audit window for the IRS.
Certain forms related to foreign income, assets, and gifts also warrant an unlimited audit timeframe. If you miss filing one of these forms, the statute of limitations will not begin, giving the IRS an unlimited window to conduct an audit.
While the chances of being audited are relatively small, certain factors can increase the likelihood of an IRS audit. Being aware of these triggers can help you ensure your tax return deductions and claims are accurate and well-documented. Here are 12 common audit triggers:
It's essential to remember that an IRS audit is not a penalty but a process to ensure tax compliance. However, it can be an arduous process, especially if your records are not in order. Therefore, maintaining good records, reporting all income, and being mindful of audit triggers can help you navigate an IRS audit smoothly.
Since the IRS can audit the past three years' tax returns, you should keep all tax returns and records for at least three years. However, some experts recommend keeping tax returns for up to six or seven years in case the IRS goes back further than three years when conducting an audit. If you fail to file a tax return, the IRS can conduct audits going back indefinitely.
If you receive a notice from the IRS that your tax return is being audited, the most important thing is to respond promptly and cooperatively to all IRS requests. Often, the audit can be handled by mail, and you may not even have to meet the auditor in person. However, depending on how complex the audit is and how much money is involved, you might want to consult with a tax professional.
Q: How far back can the IRS audit? A: The IRS typically has three years to audit your tax returns once they are filed. However, certain exceptions can extend this period to six years or even indefinitely.
Q: What triggers an IRS audit? A: Numerous factors can trigger an IRS audit, including math errors, high income, unreported income, excessive deductions, filing Schedule C, claiming 100% business use of a vehicle, claiming a loss on a hobby, home office deduction, deducting business meals, travel and entertainment, claiming the EITC, dealing in cryptocurrency, and taking early withdrawals from retirement accounts.
Q: How long should I keep my tax records? A: It is recommended to keep all tax returns and records for at least three years. However, some experts suggest keeping tax returns for up to six or seven years in case the IRS goes back further than three years when conducting an audit.
Q: What should I do if I am audited by the IRS? A: If you are audited by the IRS, respond promptly and cooperatively to all IRS requests. Depending on the complexity of the audit and the amount of money involved, you might want to consult with a tax professional.
Understand the audit process: Knowing what an IRS audit entails can help you prepare for it and respond appropriately if you are audited.
Know the statute of limitations: The IRS typically has three years to audit your tax returns, but certain situations can extend this period to six years or even indefinitely.
Be aware of audit triggers: Understanding the factors that can trigger an IRS audit can help you ensure your tax return deductions and claims are accurate and well-documented.
Keep good records: Keeping detailed and accurate records can prove invaluable if you are audited by the IRS. It's recommended to keep all tax returns and records for at least three years.
Seek professional help if necessary: If you are audited by the IRS and the audit is complex or involves a large amount of money, consider consulting with a tax professional.
An IRS audit can be a daunting prospect, but understanding the process, the statute of limitations, and the triggers for an audit can help you prepare for it and respond appropriately if you are audited. Keeping detailed and accurate records and seeking professional help when necessary can also make the audit process smoother. By being proactive and informed, you can navigate an IRS audit with confidence and ease.
Our digital compliance software, Capptions, can be invaluable when it comes to preparing for and navigating through an IRS audit. By helping you streamline and digitize your compliance processes, Capptions allows you to maintain accurate and detailed records, making it easier to respond to an IRS audit if needed. By being proactive and leveraging the power of digital tools like Capptions, you can ensure your tax compliance and be prepared for any IRS audits that may come your way.
Remember, an IRS audit is not a penalty but a process to ensure tax compliance. Understanding this process, maintaining good records, and being mindful of audit triggers can help you navigate an IRS audit smoothly.