The worst thing that can happen for most taxpayers is being told by the IRS that they are being audited. However, what most people don’t realize is that there is a timeframe for how long the IRS can audit an individual. This timeframe is known as the audit statute of limitations. Taxpayers have a right to dispute an IRS audit if they have proper substantiation. In this article, we’ll explain how long the IRS has to audit taxes and what factors may affect this timeline.
Audit Statute of Limitations: The Three-Year Rule
Section 6501(a) of the Internal Revenue Code sets out the rule for the IRS audit statute of limitations. The IRS generally has three years from the date a tax return is filed to assess any additional taxes owed. It starts ticking on the date the return is filed.
Exceptions to the Three-Year Rule
The three-year rule serves as a broad guideline. However, there are exceptions and circumstances that can extend or suspend the audit statute of limitations. Some key exceptions include:
Substantial Omission of Income:If a taxpayer omits more than 25% of their gross income on their tax return, the IRS has six years from the filing date to assess additional taxes.
No Return Filed: If a taxpayer fails to file a tax return, the statute of limitations doesn’t apply, and the IRS can initiate an audit at any time.
Agreements and Extensions: If a taxpayer agrees to extend the statute of limitations or signs an agreement with the IRS, the audit period may be extended.
Omission of Foreign Income: If a taxpayer omits more than $5,000 of their foreign income on their tax return, the IRS has six years from the filing date to assess additional taxes.
Omission of Gifts or Inheritances: If a taxpayer receives a gift or inheritance of over $100,000 from a non-U.S. person and does not file Form 3520, the IRS can initiate an audit at any time.
Fraudulent Returns: In cases of fraud or the willful intent to evade taxes, there is no statute of limitations. The IRS can initiate an audit at any time.
Audit Process
Flagged tax returns typically end up going into an IRS audit. At this point, these taxpayers may receive an IRS notice called a CP2000. The IRS agent will be required to open and close an audit within 26 months after a tax return has been filed. The IRS strictly adheres to its guidelines to ensure that the audit is complete within the three-year timeframe.
For audits that start a few months after a return is filed, the IRS will typically freeze any refunds. However, the IRS will have to pay interest on refunds that are sent late. This is why the IRS will attempt to resolve its audit quickly. Once a taxpayer answers the questions regarding their tax return with accuracy, their refund will be released and sent out. Audits that happen immediately after filing a tax return typically contain tax credits. Usually, these will include earned income tax credits, and the child tax credit. The IRS usually wants to verify the filing status, dependents, and other return items before sending your refund.
Practical Considerations
While the IRS has a specified period to initiate an audit, taxpayers should keep their tax records for at least three years after filing. However, keeping records for an extended period, such as seven years, can provide an added layer of protection. This is especially true if there are concerns about substantial omissions or potential audits related to certain transactions.
Seek Help if You’re Being Audited
Understanding the IRS audit statute of limitations is crucial for taxpayers to navigate the complexities of tax compliance confidently. While the general rule is a three-year window for the IRS to initiate an audit, exceptions can affect this timeframe. As tax laws and regulations are subject to change, it is advisable to consult with a tax professional to stay informed about any updates that may impact the audit process. By maintaining accurate records, individuals and businesses can mitigate the risks associated with IRS audits. Optima Tax Relief provides assistance to individuals struggling with unmanageable IRS tax burdens.
While there is no guaranteed method of avoiding tax audits, there are things that could help trigger them. Since the Senate approved nearly $80 billion in IRS funding through the Inflation Reduction Act of 2022, with $45.6 billion specifically for enforcement, the IRS has promised an increase in tax audits. Below are some things that the IRS has historically viewed as “red flags,” which could increase the chances of an audit for taxpayers. But first, let’s review the different types of audits.
Types of IRS Audits
The IRS conducts different types of audits to review and verify taxpayers’ financial information and ensure compliance with tax laws. There are three primary types of IRS audits:
Correspondence Audits: These are the most common and least intrusive type of IRS audit. In a correspondence audit, the IRS requests specific documentation to support claims on their tax return. Typically, these audits are focused on one or a few specific issues, such as income, deductions, or credits. Taxpayers can respond to these audits by mail, providing the requested documentation and explanations.
Office Audits: An office audit, as the name suggests, takes place at an IRS office or a local IRS branch office. The IRS will contact the taxpayer to schedule a face-to-face appointment for the audit. The taxpayer will be required to bring the necessary records and documentation to the IRS office. Office audits are often more comprehensive than correspondence audits as they can cover a wider range of issues on a tax return.
Field Audits: Field audits are the most extensive and thorough type of IRS audit. In a field audit, an IRS agent comes to the taxpayer’s home or business to conduct the audit in person. These audits are usually reserved for more complex or high-risk cases. That said, they can involve a comprehensive review of a taxpayer’s financial records and activities. Field audits are often conducted when there are significant discrepancies or concerns about a taxpayer’s compliance with tax laws. However, note that the IRS has halted most unannounced visits to taxpayers.
Reporting a Business Loss
The IRS will be more inclined to audit a taxpayer who reports a net business loss, even if it’s small. Reporting losses year after year will only increase IRS interest in your tax returns. Remember, it is mandatory to report all earnings in a tax year. However, it might be helpful to reconsider which expenses should be deducted from your tax return. Reporting even a small profit could reduce the chance of being audited by the IRS.
Being Vague About Expenses
When it comes to expenses, the more detail the better. This is especially true when categorizing them on your return. Try to avoid listing expenses under “Other Expenses” as this will lead to more scrutiny from the IRS. It may even be helpful to provide supplemental documentation explaining why certain expenses drastically increased or decreased for that year. Doing so can give potential auditors a valid explanation for such occurrences and possibly avoid a tax audit. Additionally, rounding dollar amounts are red flags for the IRS. You should always use exact dollar amounts on your tax return.
Filing Late
Some taxpayers believe that filing late can actually decrease the risk of being audited. However, filing on time, as well as paying on time, can help establish a history of IRS compliance. This will be far more beneficial in the long run. In addition, not filing by the due date will also result in receiving your tax refund later if you are expecting one. Even worse, if your late filing triggers an audit, it may prompt the IRS to look at older tax returns you’ve filed. If they find any other errors, this can add additional time to their normal processing schedule.
Claiming Excessive Deductions
It is best to avoid any excessive expenses. For example, deducting the cost of your breakfast and lunch each workday may not be acceptable to the IRS. Excessive deductions for your donations to charitable organizations can also increase the chances of being audited. Inflating business expenses can result in being audited, especially if you try to claim large amounts for business entertainment or claim a vehicle that is used for only business purposes 100 percent of the time.
Now that home offices are more common, it’s important to only claim the home office deduction for the portion of your home that is used exclusively for business purposes. When claiming this deduction, you will need to figure out how much square footage in your home is dedicated to your business. For tax year 2023, the rate for the simplified square footage calculation is $5 per square foot, with a maximum of 300 square feet or $1,500. Excessive deductions claimed on your return are fast tracks to being audited by the IRS. That said, it’s best to only claim the deductions you actually qualify for to avoid owing any additional taxes.
Keeping Poor Records
Even the simplest tax situations require adequate records. If your finances are more complicated, then detailed records are necessary. Some taxpayers may feel inclined to estimate their expenses because they did not save receipts or documents, which the IRS views as a red flag. It’s important to make sure you have detailed records for the past three tax years at minimum. Having items like your previous tax returns, medical bills, business receipts, real estate documents, and investment statements can help substantiate your claims and avoid an IRS audit.
Choosing the Wrong Filing Status
Your filing status (single, married filing jointly, married filing separately or head of household) determines how you treat many tax decisions, such as what forms you’ll fill out, which deductions and credits you’ll take and how much you will pay (or save) in taxes. Select the wrong status, and it will trigger a cascade of mistakes–maybe even an audit. On top of that, if you decide to file jointly with your spouse, this means you’re responsible for any errors or deliberate falsehoods on your partner’s return, so make sure that you’re comfortable with what it says.
Tax Relief for Those Being Audited
The chances of being audited are low, but those chances increase when the IRS notices any of the above red flags. The audit process can be very stressful. It is a tedious process that requires collecting information regarding your income, expenses, and itemized deductions. Failing an audit can result in a huge, unexpected tax bill. It’s best to seek assistance from experts who can help you avoid an IRS audit. Remember, filing your taxes correctly the first time can help avoid interest, tax penalties, and additional taxes owed. Optima Tax Relief is the nation’s leading tax resolution firm with over $1 billion in resolved tax liabilities.
The Inflation Reduction Act of 2022 has equipped the IRS with more than $80 billion in funding. That means more audits and more enforcement. CEO David King and Lead Tax Attorney Philip Hwang provide helpful tips on what you can expect from the IRS moving forward and how you can resolve your tax burden.
Failing to pay, or even underpaying, your taxes can have drastic consequences that can cost a fortune. This is because on top of your unpaid tax balance is a heap of penalties and interest. One of the most common penalties to watch out for is an accuracy-related penalty. These can include a substantial understatement of income tax penalty and a negligence penalty. While a substantial understatement of income tax penalty usually requires an individual to lie about their income, a negligence penalty can result from being careless or reckless with your tax return. Here’s a breakdown of what the IRS negligence penalty is and how to avoid it.
Negligence or Disregard of the Rules or Regulations Penalty
The IRS may impose the negligence penalty on taxpayers who fail to use reasonable care or who make mistakes on their tax returns. Negligence is the failure to act with the same degree of caution that a reasonably cautious person would in a similar situation. In the context of tax returns, negligence can include the failure to maintain accurate records. It can also include failure to declare all income or to confirm the validity of a tax deduction or credit.
How Negligence is Penalized
The negligence penalty can be up to 20% of the portion of the underpayment of tax resulting from negligence. In addition to this penalty, the IRS also charges interest on the penalty. The current quarterly interest rate for underpayment is 8%.
Tax Negligence vs. Tax Fraud
The difference between the negligence penalty and the IRS’s fraud penalty should be noted. The fraud penalty can be applied to taxpayers who knowingly and purposefully understate their tax liability. It is significantly more severe. Taxpayers who make errors are subject to a less severe penalty known as negligence.
If the IRS determines that a taxpayer has been negligent when preparing their tax return, they will typically send the taxpayer a notice informing them of the penalty. The taxpayer will then have the opportunity to dispute the penalty. They will need to provide additional information or argue that they were not negligent.
The IRS will normally issue the taxpayer a notice advising them of the penalty if they are found to have been careless when preparing their tax return. The taxpayer will then have the chance to contest the penalty by offering more substantiating details or making a case that they weren’t negligent.
Avoiding the IRS Negligence Penalty
It is important for taxpayers to take the necessary steps to ensure that their tax returns are accurate and complete. This involves keeping precise records, disclosing all earnings, and only claiming the deductions and credits that they qualify for. The purpose of the IRS negligence penalty is to motivate taxpayers to take the required precautions to guarantee the accuracy and completeness of their tax returns. Additionally, it ensures sure that taxpayers cannot profit from their errors or carelessness at the expense of other taxpayers. If you’ve been hit with IRS penalties, like the negligence penalty, Optima Tax Relief can help.
While there is no guaranteed method of avoiding audits, there are things to steer clear of that could trigger an IRS audit. The Senate recently approved nearly $80 billion in IRS funding, with $45.6 billion for enforcement, which could lead to more audits. Here are some things that the IRS has historically viewed as “red flags,” which could increase the chances of an audit for taxpayers.
Reporting a Business Loss
The IRS will surely be more inclined to audit a taxpayer who reports a net business loss, even if the loss is small. Reporting losses year after year will only increase IRS interest in your tax returns. Remember, it is mandatory to report all earnings in a tax year. However, it might be helpful to reconsider which expenses should be deducted from your tax return. Reporting even a small profit could reduce the chance of being audited by the IRS.
Being Vague About Expenses
When it comes to expenses, the more detail the better. This is especially true when categorizing them on your return. Try to avoid listing expenses under “Other Expenses” as this will lead to more scrutiny from the IRS. It may even be helpful to provide supplemental documentation explaining why certain expenses drastically increased or decreased for that year. Doing so can give potential auditors a valid explanation for such occurrences and possibly avoid a tax audit. Additionally, rounding dollar amounts are red flags for the IRS. You should always use exact dollar amounts on your tax return.
Filing Late
Some taxpayers believe that filing late can actually decrease the risk of being audited. However, filing on time, as well as paying on time, can help establish a history of IRS compliance. This will be far more beneficial in the long run.
Claiming Excessive Deductions
It is best to avoid any excessive expenses. For example, deducting the cost of your breakfast and lunch each workday may not be acceptable to the IRS. Excessive deductions for your donations to charitable organizations can also increase the chances of being audited. Inflating business expenses can result in being audited, especially if you try to claim large amounts for business entertainment or claim a vehicle that is used for business purposes 100 percent of the time. Also, remember to only claim the home office deduction for the portion of your home that is used exclusively for business purposes. When claiming this deduction, you will need to figure out how much square footage in your home is dedicated to your business. For tax year 2023, the rate for the simplified square footage calculation is $5 per square foot, with a maximum of 300 square feet or $1,500.
Keeping Poor Records
Even the simplest tax situations require adequate records. If your finances are more complicated, then detailed records are necessary. Some taxpayers may feel inclined to estimate their expenses because they did not save receipts or documents. Unfortunately, the IRS views this as a red flag. It’s important to make sure you have detailed records for the past three tax years at minimum. Having items like your previous tax returns, medical bills, business receipts, real estate documents, and investment statements can help substantiate your claims and avoid an IRS audit.
Choosing the Wrong Filing Status
Your filing status (single, married filing jointly, married filing separately or head of household) determines how you treat many tax decisions. it affects what forms you’ll fill out, which deductions and credits you’ll take. It ultimately determines how much you will pay (or save) in taxes. Select the wrong status, and it will trigger a cascade of mistakes–maybe even an audit. On top of that, if you decide to file jointly with your spouse, this means you’re responsible for their errors. This includes deliberate falsehoods on your partner’s return, so make sure that you’re comfortable with what it says.
Tax Relief for Those Being Audited
The chances of being audited are low, but those chances increase when the IRS notices red flags. The audit process can be very stressful. It is a tedious process that requires collecting information regarding your income, expenses, and itemized deductions. Failing an audit can result in a huge, unexpected tax bill. It’s best to seek assistance from experts who can help you avoid an IRS audit. Our team of qualified and dedicated tax professionals can help.
