Fear of IRS audits makes filing taxes that much more stressful: Did I do everything right? Did I miss something? Is the IRS going to be banging on my door?
To alleviate those fears, it’s important to understand how IRS audits work. That way, you’ll know why some returns get selected for audit and how best to prepare for one.
I wanted to shed light on this as a former IRS auditor who got to see the process happen firsthand. After eight years on the job, I developed a pretty clear understanding of how the entire system works.
I’ll share that understanding with you, so you can be prepared.
What types of audits are there?
For taxpayers, the two most relevant types of audits are:
- Correspondence audits
- Office or field audits
These are the most common. (Other types, like information gathering audits, preparer project audits, and claims audits are much rarer.)
A correspondence audit is where the IRS mails you an audit notice asking for additional documents. You either fax or mail them in to a general IRS location, and you never meet with a specific auditor.
These are the most common types of audits. They’re usually triggered if something on your return doesn’t match something else filed in the IRS system.
What might trigger a correspondence audit?
For example, say you file your return without an interest income, but the IRS has a 1099-INT on file for you, with interest income of $100. You get a letter saying you forgot to include that income.
What should you do when you get an audit letter?
That depends on why your return doesn’t match the IRS’s system:
- If the IRS has it wrong: Sometimes, these amounts are left off legitimately. At that point, you need to respond to the IRS’s letter with information and documents proving you were right in leaving them off your return. (Unfortunately, there’s no way to preemptively explain any of this. All correspondence audits are computer-selected, and the IRS computer system more or less can't read)
- If you had it wrong: Plenty of times, this is simply due to an accidental slip-up. You’ll just need to pay the difference in tax, plus any penalties and interest for late payment
How can you avoid correspondence audits?
Avoiding these types of audits is as simple as including all your reported income on your tax return when you file.
Office and field audits
Office audits are what people typically think of when they picture being audited, so I’ll focus on them for the rest of the article. This is where you pack up folders of receipts and drive down to a big building, where Jamie Lee Curtis goes through everything and tells you if you did things right.
How do you get there? Let’s go through the path of audit selection and find out.
How do tax returns get selected for audit?
There’s no group of people sitting in a room, combing through papers and stamping a big “Audit This” on returns they don’t like. There are far too many returns filed every year for this to even be feasible.
Instead, here’s what happens: The IRS computer system looks through all the numbers on a national scale and spits out returns that deviate too much from the average return.
How many tax returns get audited?
Less than 1% of all tax returns are audited, mainly thanks to limited manpower inside of the IRS. You might have heard rumors that 87,000 new auditors are being hired. Even if that were true, the audit rate would still be minimal.
That’s not happening, by the way. A large percentage of the IRS’s new hires are either replacing retiring employees or are going into administrative roles. The IRS needs tech and customer support more than it needs auditors.
What does the audit selection process look like in action?
Pretend your income on your return was $100,000, and you donated $5,000 to charity in your itemized deductions. The system will review millions of other returns to decide whether $5,000 is significantly different from what other people with similar incomes donate.
Getting flagged for something like this doesn’t mean an automatic audit. The system simply adds each such deviation to your score. And returns with a high enough score get put into a pool for random selection.
Can deductions that are too small trigger an audit?
Maybe. Larger-than-average deductions are obvious red flags. But deductions that are way smaller than average can also be signs that something went wrong.
Realtors usually have a ton of mileage deductions. So either they put them in the wrong place, or they didn't know to deduct them. Either way, it's likely they messed up somewhere else too.
Say a return looks “off” enough to get sent into the random selection pool. How does the IRS decide whether it actually gets audited?
The reality is, audit selection is just that: random.
How does audit selection work for business owners?
If you own a business, you may be wondering how this works for your business expenses, since all businesses differ.
That’s where the 6-digit NAICS code comes in. These codes help the IRS make sure it’s comparing your return to other returns filed by people in the same line of work.
What NAICS codes mean for the audit process
When the IRS reviews your expenses, it compares your return with all the other returns filed by artists under that same business code. That way, your write-offs for expenses like art supplies and studio rent get put in context. As long as your amounts make sense, they won’t raise any red flags.
The Keeper app also uses your business code to review your transactions for legitimate business expenses you might have missed. You can always verify these with their human tax assistants as well.
Can you prevent audits by refusing to specify an industry on your return?
Not likely. Some tax preparers feel like adding in the code “999999” helps shield you from audit, since that code isn’t associated with any specific industry.
There’s no evidence to show it works this way. In fact, plenty of those businesses do get selected for audit.
What happens after a tax return gets flagged for audit?
One common misconception is that the things that get a return flagged for audit will automatically get audited.
What actually happens: the tax returns that get selected are sent in batches to IRS agents, who look through them and select audit issues by hand. This process is called “audit classification.”
How audit classification works
During audit classification, experienced agents go through hundreds of returns selected for audit and decide two things:
- Should the return actually be audited, and at what level?
- What issues are actually going to get audited?
Let’s talk about both of them.
Question #1: Should the return actually be audited?
For the first step, sometimes the computer gets it wrong. A return might get through because it had a high enough “score” to be selected. But then the agent who looks it over decides there aren’t enough genuine red flags for audit.
So, like a small fish in a pond, it gets thrown back.
Question #2: What issues are actually going to get audited?
When I worked for the IRS, the standard for all audits was to select three line items to investigate. No more, no less.
Note: The agents classifying the returns don’t get access to any information about why the IRS computer system selected the return for audit. What they choose to audit might not overlap with what the computer selected at all.
For example, your return might have been selected because your “Supplies” expense was larger than average for your industry. But maybe that particular expense item may never actually gets audited.
How do IRS agents select issues for audit?
Typically, the three highest expenses on a business return get selected for audit — unless there’s something especially off elsewhere.
That’s why “Car & Truck Expenses” and “Other Expenses” get audited significantly more than other categories — because they often have higher values.
Now, let’s talk about what happens after the audit issues get selected. Will the auditor look at anything beyond those specific issues?
Sometimes, but not always!
When will auditors look at an entire return?
With approval from management, auditors are free to take a closer look at an audited return, beyond just the issues that were selected for audit. This process is called “in-audit expansion.”
In-audit expansion tends to happen if something on the return stands out — or if something comes up in the audit meeting that warrants adding on more audit issues.
Note: Most agents know how much time they have to spend on each audit, which might range from eight to 10 hours for an office audit. So they won’t expand an audit to cover the entire return for no reason.
Can you avoid in-audit expansion?
Not always, but the information you provide when being audited can make a difference.
That’s why many tax professionals advise you to only respond to (and provide documentation for) the specific items you’re asked about.
If you run your mouth and talk about the rent expense that you weren’t sure qualified for a write-off, that might reveal enough information to make the auditor want to expand the audit.
Is there anything auditors always look at?
Yes. Income is always an audit issue by default — even if it’s not specifically selected during classification.
Why? As part of every audit, the auditor has to administer a questionnaire and workpaper to confirm that the taxpayer didn’t have any outside income sources that haven’t been reported. They also have to confirm that gross receipts from the taxpayer’s businesses look reasonable.
This doesn’t mean they’ll look through all your deposits every time, but it’s possible.
If you get audited once, will you audited again?
Not necessarily. Being selected for audit does not make you more likely to be randomly selected for audit in the future.
But remember — you were selected for a reason. So there are a couple of reasons “repeat” audits might happen:
- If the agent chooses to audit similar returns
- If you keep triggering the IRS computer system in the same way
In both these cases, it’s because the errors or inconsistencies that got you audited in the first place might land you in the same position.
Repeat audit reason #1: The agent chooses to audit similar returns
Pretend that, in the audit, the IRS agent determines they’ll be making significant adjustments to your return. They then see similar red flags on a return you filed before or after the one they audited.
In this situation, the agent will likely pick up that additional return — as long as the statute of limitations hasn’t run out. They do get three years to audit the return.
Because of this, it’s possible for a one-year audit to turn into a three-year audit if you repeatedly made the same errors.
Repeat audit reason #2: You keep triggering the IRS computer system the same way
If your return was significantly different from the average return, and you file the same way every year, you’re essentially at risk for random audit selection every year.
The good news is, the agent running your audit can decide to remove audit issues they see as redundant.
For example, pretend you get audited year after year because your business has an unusually large amount of travel expenses.
You always justify this during the audit. So after a few years of this, the agent can look at your history and request to remove that particular audit issue.
What happens at the end of the audit?
There are four different possible audit outcomes you may see, depending on the validity of the information you provide during the audit:
This means absolutely nothing was adjusted in the audit. Congratulations, you’re perfect.
This is the hardest for an auditor to get approved by management, simply because they want to ensure the auditor did their job.
No change, with adjustments
“No change” here means no change in the amount of tax due — even if some things about your return need to be adjusted.
This happens when adjustments are made that either:
- Don’t change the amount of tax that needs to be paid
- Change it minimally enough that the IRS isn’t going to pursue it
When I was with the service, the threshold for this was $200 in additional tax due.
Extra tax due
Adjustments were made to the return, and unfortunately, you have to pay more in taxes. (No, jail time is not on the table.)
The good news is, you can always go on a payment plan, just like with any other tax bill. With one of these, the IRS typically allows for up to six or seven years to pay it off. (Keep in mind, interest and penalties continue to rack up in the interim).
One additional note: Auditors are not in IRS Collections. They’ll provide you with options for payment and can forward a check to the right department, but they’re not there to collect.
So no, once the audit concludes, they will not lock all the doors and start reaching for your wallet.
Is there anything more magical than being called into the IRS for an audit and leaving knowing they owe you money?
While not a super common outcome, it’s not impossible. Maybe you forgot to put some business expenses on your return, and you didn’t find out about it until you were forced to go through your records.
I’d estimate less than 5% of my audits ended like this, with the refunds ranging from $100 to — in one memorable case — $70,000.
Don’t worry, the auditor doesn’t get in trouble if this happens. An auditor’s job is to adjust the return so it’s as accurate as possible, whatever that might mean for the tax bill.
Just be glad that, in this case, it’s in your favor.
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At Keeper, we’re on a mission to help people overcome the complexity of taxes. We’ve provided this information for educational purposes, and it does not constitute tax, legal, or accounting advice. If you would like a tax expert to clarify it for you, feel free to sign up for Keeper. You may also email firstname.lastname@example.org with your questions.