You've received a letter from the IRS regarding an audit. What is your plan? Assuming the fetal position? Heavy drinking? Fleeing the country? Spontaneous combustion? None of these actions is necessary. Simply stay calm and assess the situation objectively.
The letter you receive may be one of three types:
Adjustment Letter – This notifies you of a change in your taxes owed, or the refund amount. In this case, it is generally from an obvious wrong number entry or miscalculation on your form.
Correspondence Audit – This letter asks for further information to verify your tax return; such as a W-2 form that does not match the amount reported by your employer. The letter will tell you exactly what information is needed and how to respond. It is possible that your entire audit can be dealt with via correspondence. This is the most common form of audit.
Examination Audit – This in-person audit is what most people envision... and fear. The letter will let you know the nature of the audit, what information is needed, and how to schedule an in-person appointment. The appointment may take place in your home, place of business, or at an IRS office. You generally have ten days to schedule an appointment.
There is a comprehensive list of notices and letters at the IRS website, along with links for further explanation. All letters and notices will contain the reason for the letter, its purpose, and how to respond.
Once you have read your letter and understand the issue, what's next?
Step 1. Don't Ignore the Issue – Ignoring the problem will not make it go away. The issue may be simple, such as acknowledging a math error, and may only require sending a check. In any case, you have a set amount of time to reply. This varies depending on the type of notice, but it is typically 30 or 60 days. If you have to pay interest, the more you delay, the more you will have to pay.
Step 2. Do you Need Representation? – You probably need representation by a CPA or attorney if you disagree with their findings, cannot find the documentation the IRS requested, or have a more complex tax issue.
You are still responsible for your return even if you had a third party prepare it for you. Take advantage of whatever audit defense is included with your contract. Professional tax-preparation does not guarantee freedom from an audit.
Step 3. Audit Preparation – Gather all the information requested, and have it organized. Make sure you have the correct year – IRS audits can involve returns from up to three years prior, and two years is not uncommon. It is wise to keep records for up to six years.
Step 4. The Audit – Bring all the requested information with you, and answer the auditor's questions to the best of your ability. Do not bring extra information, or discuss other issues – stick to the focus of the audit. You may have your representative with you during the audit, and you may make an audio recording as long as you provide advance notice.
Step 5. The Conclusion – The auditor will either agree with you and resolve the matter, or rule against you and require you to pay some additional taxes. There may be penalties and interest charges that you are liable for as well. You can choose to pay, or fight in court if you think your chances of success are good and the amount at stake is much greater than the legal fees.
The good news is, if you filed your return honestly -- and maintained thorough documentation and proof of your deductions – any additional taxes due are likely to be manageable. Consequently, keep your records in order, follow the IRS instructions, and get representation as needed. Your audit experience should be less painful than you fear it will be. And if you do assume the fetal position, snap out of it long enough to take care of business.