What to Expect During an IRS Correspondence Audit

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The IRS only audited 0.6% of individual tax returns from the 2016 tax year. That means that for 2016, your chance of being audited was 1 in 160.

There are many cases, however, considered as “unreal” audits. In these cases, taxpayers may receive a letter that requires more information or payment due.

The National Taxpayer Advocate’s office says that 6.2% of 2016 taxpayers were given unreal audits.

But regardless of how unlikely an audit is, 25% of Americans still fear it.

Of Americans who earned over $1 million last year, only 3% received audits.

Are you a professional facing a correspondence audit? Keep reading to learn all about what it is and what to expect during the process.

What Types of Audits Are There?

There are 3 types of audits the IRS uses.

Correspondence Audit

If you’re facing a correspondence audit, you can rest easy knowing that it’s the least intrusive of all 3 types of IRS audits. It focuses on a few different issues, such as unusual or questionable deductions, or omitted income.

Office Audit

Office audits and field audits are done face-to-face. The review is conducted by IRS personnel known as Revenue Agents or Tax Compliant Officers.

Office audits involve less complex returns and are audited at a local IRS office during a scheduled appointment.

Field Audit

The field audit is conducted by a Revenue Agent, too, but it’s the most comprehensive of the 3 types.

Typically, it involves the agent’s request for an in-person interview. For business owners, they’ll also ask for a tour of the business.

What Is a Correspondence Audit?

A correspondence audit isn’t as intense or extensive as other audits, such as face-to-face ones. For a correspondence audit, an agent usually conducts the correspondence through letters and phone calls to work with a representative or the officers of a particular organization.

It can, however, expand and become an in-person audit. This will only happen, though if the issues grow more complicated or the individual or organization in question doesn’t respond.

MOST IRS audits are conducted as correspondence audits. If your return gets picked or flagged, you can rest easy knowing that you probably won’t have to meet with an IRS agent face-to-face.

You do have to make sure that you respond in a timely matter to all correspondence sent to you, though.

Sometimes, all the IRS needs is more information to process your return. This request comes in the form of a 566 letter. Its purpose is to provide you with a list of what documents you’re missing to verify that your submitted return is correct.

If you get a 566 letter, all you have to do is provide that requested documentation, and the matter should get put to rest.

Even though most audits are conducted relatively quickly, the IRS still has up to 3 years to audit any given return. That means you aren’t off the hook for any particular year until that 3-year mark has passed.

Keep all your records and corresponding paperwork until AT LEAST that 3 years have passed. If you can, keeping all your tax documents for at least 10 years is optimal.

What to Expect in an IRS Audit

When the taxpayer asks for additional information, the IRS will attempt to answer their questions. If necessary, telephone contact will be made. The IRS makes every effort to process replies within 45 days after they’re received.

If the taxpayer’s return correspondence to the IRS includes an acceptable explanation to the IRS’ proposed adjustment, then the taxpayer will receive a “no-change” letter. 

However, if the taxpayer’s return correspondence to the IRS is NOT satisfactory, then the IRS will issue a 30-day letter advising the taxpayer of their appeal rights and proposed tax changes.

If the IRS still needs additional information or documentation, even after the taxpayer responds, then that individual or business will receive a further letter with a request for more documentation.

If, at that point, the 2nd explanation is still not sufficient to satisfy the IRS’ request, then the return might be transferred to a local office for further review of the taxpayer’s return.

What If the Taxpayer Doesn’t Respond to Any Letters?

Typically, you have 30 days after receiving an IRS letter to respond.

If a taxpayer hasn’t responded within those 30 days of an initial contact letter, then the IRS will issue a second letter, called a 30-day letter. That letter explicitly gives the taxpayer 30 days to respond.

If the taxpayer doesn’t respond for a second time, then the IRS will issue a notice of deficiency. At that point, the taxpayer will have 90 days to file suit to contest the determination made by the IRS.

They’ll file suit in the United States Tax Court.

What Are “Unallowable Items?”

More often than not, the reason for a 556 letter is because of “unallowable items.”

Unallowable items are referenced through the Unallowable Items Program, which uses a computer to identify which items claimed by a taxpayer, are unallowable by law.

Some examples of these items are:

  • Deduction for a married couple when both partners work
  • Gambling winnings
  • Disability income exclusion
  • Automobile expenses
  • Medical expenses
  • Income earned in a foreign country
  • Casualty loss
  • Sale or purchase of a personal residence
  • Federal taxes
  • Utility taxes
  • Automobile license
  • Tag fees or taxes
  • Registration
  • Charitable contributions as they relate to automobile expenses
  • Personal insurance premiums
  • Adoption expenses
  • Personal living expenses
  • Political contribution
  • Disabled dependent care expenses
  • Childcare expenses
  • Partial exemptions
  • Personal exemptions
  • Foreign tax
  • Interest and taxes

If a return gets identified for containing unallowable items, the taxpayer is then contacted via correspondence from the IRS Campus, and any necessary corrections to the return must be made.

The letter requests that the taxpayer agrees to the adjustments. Any disagreement must be returned in writing, and as long as a satisfactory explanation gets submitted, the matter will conclude.

Otherwise, the IRS keeps the matter for a correspondence examination. If no agreement is reached, it could end up being settled in the United States Tax Court.

How Are Taxpayers Selected for an Audit?

Candidates for tax audits are selected in the same way, whether it’s an in-person audit or a correspondence audit.

Sometimes the selection is random. Other times a computer program, as we mentioned above, detects an irregularity in a taxpayer’s return.

If the tax authorities receive tips from informers alleging wrongdoing or tax evasion by a particular taxpayer or business, the IRS might also select them for an examination audit.

What Are the Odds of Being Selected?

Every year, around 1% or less of all tax returns are selected for examination.

The percentage varies on income, and those with higher incomes are more likely to get chosen.

Out of all the businesses and individuals selected for an audit, 75% undergo a correspondence audit, whereas 25% experience a traditional examination audit.

What’s a DIF Score?

The IRS uses a data analytics program called Discriminant Index Function to screen tax returns.

It’s been around since 1969 when the IRS first started using it. The program is based on algorithms that are classified. 

What the program does is perform an analysis of various lines of a given return. Based on that analysis, the program assigns a numerical score to each return.

Think of it as the credit scoring system, which provides a numerical score indicating an individual’s credit value or worthiness. The DIF system does essentially the same thing; only that score indicates the probability of error for every return it scans.

How Should You Respond to a Correspondence Letter?

An essential thing you can do is never to ignore any correspondence letters sent by the IRS.

Doing so will only put you in a more vulnerable place, especially if you miss a deadline or fail to respond.

Any letter the IRS sends with a request for more information will always contain a deadline within which the individual has to respond.

If a taxpayer can’t meet a deadline, they can call the telephone number on the letter to explain why they need more time and put in a request for that extra time.

If the correspondence asks you to send additional documentation in support of your tax return, make sure you don’t send original copies of the documents. Send photocopies and keep your originals in a safe place.

If you’re worried about your audit, you aren’t alone. An experienced tax attorney can guide you through the entire process.

And if you are worried the IRS will find more significant issues in your correspondence, you shouldn’t hesitate to get help from a professional with reviews to show for their work.

A Correspondence Audit Is the Least Invasive

While there are 3 types of IRS audits, a correspondence audit is the least invasive. If you’ve received notice from the IRS asking you for additional documentation, don’t ignore it. 

The chances are that it can be cleared up within one response from you, the taxpayer.

But if you’re unsure or nervous about handling it yourself, call someone who will handle most of it for you and put your mind at ease knowing an experienced tax expert is by your side.

Contact us today for a FREE evaluation!

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