The word "audit" is one of the scariest words in the English language to many people, but it doesn't have to be. Less than 1% of all tax returns filed in the U.S. are selected for an audit, and many of these are rather painless and easy to handle. In the unlikely event that your 2015 tax return gets chosen for an audit, here's what you need to know.
Three types of audits
Depending on your circumstances and the complexity of the items on your tax return that the IRS is questioning; you can be selected for one of three types of audits:
- Mail audit. This is the simplest type of tax audit, and you'll probably never even have to meet with or speak to an IRS agent. In general, a mail audit is conducted when the IRS wants additional documentation to back up a deduction you claimed on your tax return. For example, if you claim a deduction for $20,000 in unreimbursed medical bills, the IRS may conduct a mail audit requesting proof that you actually paid them. Sending the requested documentation will usually end the audit favorably.
- Office audit. This type of audit requires that you go to an IRS office for questioning and/or examination of documentation. You will be asked to bring certain information, and you may bring an accountant or lawyer with you. Note that an office audit isn't necessarily more "severe" than a mail audit -- some tax situations are simply too complex to deal with by mail. For example, if the auditor wants to examine your bank statements and ask questions about individual transactions, this can be handled efficiently in person.
- Field audit. This is when the audit is conducted at your home or business, and typically involves all or most of your tax return. While a field audit can be extremely thorough, it isn't always "worse" than the two other types. Some situations simply require a visit to resolve. For instance, if you claimed a large home office deduction, the IRS may want to verify that you actually have a qualifying home office.
What to do
The worst thing you can do is to ignore an audit letter. Here are some correct steps to take after you find out you're being audited:
- Determine which information on your tax return is being questioned.
- Gather the appropriate documentation to back up the information on your return. This can be easier said than done, since the audit will likely be for a prior year's tax return. This is why experts say you should hold on to tax paperwork for several years. Note: Only give the IRS what it asks for, not documentation for everything on your return -- after all, why invite the IRS to review everything when it's only asking for one or two papers?
- Respond as soon as possible -- an audit can require a significant amount of back-and-forth correspondence, so it's best to get the ball rolling.
- If you are worried about the audit, or simply don't want to battle with the IRS, you can hire a lawyer or representative to act in your place.
Once your audit is complete, one of two things will happen:
- If the IRS is satisfied with your documentation and explanations, the case will be closed and no additional tax will be owed.
- If the IRS is not satisfied after conducting its investigation, changes will be proposed to your tax return. You can agree to the changes and pay any additional tax, or you have the right to challenge the IRS's ruling and either set up a meeting with an IRS manager or request a formal appeals conference.
The reason I say it's important to respond promptly is that any unpaid taxes you end up owing will accumulate interest (and possibly penalties) from the date they were due. So the sooner you handle the situation, the better off you'll be. Plus, the audit letter will generally have a due date, so be sure to abide by it.
The bottom line on IRS audits
As long as the information on your return is factual and you cooperate with the IRS, an audit should be nothing more than an inconvenience. To prepare for the worst, be sure to double-check the numbers on your tax return, and keep all of your documentation organized in a readily accessible place.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.