There are 3 kinds of audits:
a correspondence audit,
a field audit or
an office audit.
Keep all supporting tax documentation for 7 years in case of an audit.
Returns claiming the Earned Income Credit are more likely to be audited by the IRS.
What is an audit?
An audit is an inspection of an individual's or entity's books and records by the IRS. If you're being audited, the IRS will send you a letter stating which type of audit applies to you. There are 3 types of audits:
Correspondence Audit — You don't need to physically see an IRS agent for this type of audit. The IRS will request documentation, and you can mail it to them instead of delivering it in person.
Field Audit — If the IRS needs to verify information about your home or business, they may come to see it. Field audits usually involve businesses.
Office Audit — You must be seen in an IRS office and provide requested documentation.
How to Prepare for an Audit
Always provide anything the IRS asks for within the requested amount of time. If you're asked to appear before the IRS, you should bring along your tax return and all of the supporting documentation for the tax year in question, along with anything else requested in your IRS letter. However, don't let the auditor keep any of your originals — always provide them with a copy of everything requested. If you find during your audit that you don't have the required documentation, it's in your best interest to pay the tax, penalty or interest.
Audit Terms to Know
Lien — This is a legal claim to your property (not seizure) as security for payment of tax debt. Essentially, the IRS is telling you your property is now eligible to be seized and is being used as a security for your debt. If the IRS files a Notice of Federal Tax Lien, all your creditors are publicly notified. Liens may occur when:
The IRS assesses your outstanding tax liability.
The IRS sends you a Notice and Demand for Payment (a bill that tells you how much you owe in taxes).
You neglect or refuse to pay the entire debt within 10 days after you are notified.
If you pay the tax due or make arrangements for payment within the allotted 10 days, the IRS will send you a Release of the Notice of Federal Tax Lien within the next 30 days.
Levy — A levy is a legal seizure of your property to pay a tax debt. The IRS may seize and sell any type of real or personal property that you own or have interest in, including cars, boats, houses, wages, retirement accounts, dividends, bank accounts, rental income, cash value of life insurance or commissions.
This won't happen unless you've first received and ignored a Final Notice of Intent to Levy and Notice of Your Right to a Hearing. These documents are delivered in person, to your place of business or to your last known address by certified mail. You can find more information about what can and can't be levied in IRS Publication 1494.
What to Keep In Case of an Audit
You should keep your tax returns and any supporting documentation for your tax returns for 7 years. Supporting documentation may include:
home mortgage statements
Forms W-2 and W-2G
Forms 1099, 1098, 1099-R, 1099-T, K-1
receipts for employee business expenses
justification of fair market value (such as H&R Block's DeductionPro) for any items donated to charity
receipts for items donated to charity with value greater than $500
receipts for charitable contributions
receipts for rental property income
brokerage statements
receipts for qualified education costs
401(k) statements
IRA contribution records
receipts for items sold at a gain
home-office-related receipts
pay stubs
copy of the front and back of the check you used to pay your tax balance due, if applicable
Which returns are more likely to get audited?
According to the IRS annual data book, individual returns where taxpayers claimed the Earned Income Credit were high on the list. Also, business owners filing a Schedule C are increasingly being examined by the IRS.
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