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.
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.
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.
Receiving an IRS notice in the mail can be scary, but the situation can be less daunting if you know what to do. First, it’s important to note that not all IRS notices are negative as some are only informational. In any case, taxpayers should know what steps to take upon receiving an IRS notice.
Do Review Your IRS Notice
The IRS will send notices for many reasons, from notifying you of a balance dueto informing you of a delay in processing your return. From inquiring whether your return is missing a schedule or form required for processing to informing you of a potential audit. Carefully review your notice for important information. If you’re unsure of what the notice means, you can look up the CP or LTR number, located on the top or bottom right-hand corner of the notice.
It also shows the date and time the IRS expects you to respond. In the best case scenario, the IRS is pursuing a correspondence audit covering one or two items of a single year’s tax return. Correspondence audits are conducted entirely by mail and makeup 75 to 80 percent of all audits. An in-person interview audit takes place at your local IRS office. A field audit is scheduled for a particular date and time but takes place in your home or office. It is considered the most comprehensive type of audit.
Do Not Panic
Understand what auditors are seeking. While each audit is different, all audits focus on three basic questions:
Is your business truly a business – or just a hobby?
If you can answer these three questions to the satisfaction of the auditor, you stand a good chance of emerging from an audit relatively unscathed.
Do Gather Your Documentation
Once you have determined what information the IRS is seeking, it’s time to begin gathering your paperwork. If the IRS is challenging a particular deduction or tax credit that you claimed, gather whatever documentation you have to support your claim. This can include bank statements, receipts, and invoices. Provide as much information as possible concerning the inquiries the IRS has made. Also, make photocopies of everything that you intend to provide to the IRS. Never give up your original documents. If you must report in person for an office audit or prepare your home or office for a field audit, ensure that your paperwork – and your representative – will be available and ready.
Do Respondto the IRS Noticein a Timely Manner
If the information on the notice looks inaccurate, you should respond with a written dispute. Doing so in a timely manner can help minimize interest and penalty fees. Be sure to include any information and supplemental documentation to support your case. However, do not volunteer information the IRS has not specifically requested. Typically, the IRS should respond to disputes within 30 days.
Do Check for Scams
Remember that the IRS will never contact you via text message or social media. In fact, initial contact from the IRS is usually via mail. If the IRS notice does not appear credible, you can always check your online tax account on the IRS website to confirm balances due, communication preferences, and more.
The IRS will notify a taxpayer if they believe that there may be fraudulent activityoccurring on their tax return. The IRS will send a letter to you inquiring about a suspicious tax return that you may have not filed. They will request that you do not e-file your return because of the duplicate social security number that was used. Act quickly should you receive this letter from the IRS to avoid further fraudulent activity with your personal information.
Do Not Ignore the IRS Notice
Some IRS notices are purely informational and require no additional action. However, do not assume this is always the case and ignore the notice. Simple mistakes made on your return or underreporting income can result in the IRS requesting action from you. A notice can also be a notification that you owe taxes and will give instructions on how to pay the balance by the due date.
Do Not Replyto the IRS NoticeUnless Instructed To Do So
Typically, a response to an IRS notice is not needed. Once you confirm a response is not required, you can proceed with other actions. Even if the notice informs you of a balance due, there is no need to contact the IRS unless you do not agree with the information on the notice.
Do Learn from the Experience
Use the situation as an opportunity to learn more about tax regulations and ensure that your future tax filings are accurate and complete. Consider consulting with a tax professional for ongoing guidance.
Tax Help for Those Who Received an IRS Notice
Even if you prepare your own returns, having a professional from Optima Tax Relief check out your response before you return it to the IRS may save you from making a costly error. The IRS allows you to be accompanied by a representative if you have been contacted for an in-person interview audit or a field audit. Take advantage of this opportunity. You’ll likely be nervous during the procedure and may share information that might prompt the IRS agent to probe beyond the original scope of inquiry. Not only that, most IRS agents prefer dealing with a professional.
The best thing to do to avoid receiving warnings from the IRS is to always ensure that you remain compliant with tax law. However, if you find yourself in a situation where you owe the IRS, tax relief is always an option. Optima Tax Relief is the nation’s leading tax resolution firm with over $1 billion in resolved tax liabilities.
Today, Optima Tax Relief’s Lead Tax Attorney, Phil Hwang, discusses IRS online accounts, including why it’s beneficial for taxpayers to have them.
Having an IRS online account can offer several benefits to individuals and businesses. Here are some of the advantages of creating and using an IRS online account:
Convenience: Online accounts provide easy and convenient access to a wide range of IRS services, including filing tax returns, checking the status of tax refunds, making payments, and managing your tax information. You can access these services from the comfort of your own home or office, eliminating the need to call the IRS.
24/7 Accessibility: You can access your IRS online account at any time, day or night. This is particularly useful for people with busy schedules, those who prefer to handle their taxes outside of regular business hours, or individuals in different time zones.
Electronic Payment Options: You can make tax payments, such as estimated tax payments, electronically through your online account, including the option to pay by credit or debit card.
Online Account Management: Your online account allows you to update your personal information, such as your address or direct deposit details. It also provides access to your tax transcripts and IRS notices.
Tax Alerts and Notifications: The IRS can send important notifications and alerts through your online account, helping you stay informed about tax deadlines, changes in your tax status, or issues that require your attention.
Creating an IRS online account can help make your experience with taxes and the IRS much easier.
Tune in next Friday for another episode of “Ask Phil.” Next week’s topic: gift taxes!
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.
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.
Today, Optima Tax Relief’s Lead Tax Attorney, Phil Hwang, discusses his 5 top tips for how to avoid an IRS audit.
File Your Taxes: Some taxpayers don’t file because they think they don’t have to. The minimum requirement to file a tax return depends on your filing status and income, but generally most U.S. citizens and permanent residents need to file. Remember, if you don’t file when you’re required to, you will be hit with IRS penalties and interest. The IRS could also file a tax return on your behalf. While this might sound like a burden lifted off your own shoulders, this could be much worse than filing yourself because it can result in owing more taxes. You can use the IRS’s online Interactive Tax Assistant to find out if you need to file a tax return.
Report All Your Income: Failing to report all your income is the quickest way to being audited by the IRS. Keep in mind that the IRS receives copies of every W-2, 1099, and other tax forms that you receive. They know exactly how much you earned in the previous year and if your reported income does not match what they have on file, you’re much more likely to be audited.
Use Common Sense with Business Expenses: This tip is for the self-employed filers. The IRS requires all business expenses to be ordinary and necessary to be deductible during tax time. This means it should be common for your industry and necessary for the production of income. Excessive meals and entertainment, trips taken for non-business purposes, and commuting costs are examples of nondeductible business expenses.
Keep Good Records of Income and Expenses: Keeping good records of income and expenses can not only help you monitor the progress and financial well-being of your business, but also keep track of your deductible expenses, prepare your tax returns, and substantiate claims made on your tax returns. The IRS recommends keeping returns, records, and other tax documents for at least three years.
Be Wary of Multi-Year Losses: If your business consistently reports losses during tax time, the IRS will likely audit you. In addition, the IRS only allows you to write off losses for three of the five previous tax years. If you can’t prove your business is beginning to turn a profit, even a small one, the IRS can categorize your business as a hobby, at which point you will be unable to deduct any of your expenses.
Tune in next Friday for another episode of “Ask Phil” where Phil will review common IRS tax forms.
If You Think You’re at Risk of Being Audited by the IRS, Contact Us Today for a Free Consultation