Generally, the IRS has up to 3 years from the date you file your tax return (or April 15, whichever is later) to “assess” additional taxes. The process the IRS uses to determine if additional taxes are owed is called the audit. The following are the three most common types of IRS audits:
Correspondence Audit – This is the most common type of audit the IRS performs. As the name suggests, a correspondence audit is just a tax audit that is done by mail. The good thing about a correspondence audit is that you won’t have to meet with an IRS representative in person – everything can be handled through the mail. In a correspondence audit, the IRS will simply send you a letter (Letter 566) seeking clarification about a specific part of your tax return. The letter will state the specific reason for the inquiry and request specific documentation to verify that part of your tax return. If you believe you are right, and you have documentation to support your claim, send it back to the IRS within 30 days. However, if you cannot support your position, and you determine that the IRS is right, then you can just send in the additional money or request an installment agreement for the additional amount due. If the specific issue in question seems like a gray area – and you aren’t sure which side is right – then consult a local tax professional.
Office Audit – The IRS uses this type of audit for situations that are too large or complex to handle through a correspondence audit. Unlike the correspondence audit, an office audit involves a face-to-face meeting with an IRS representative (auditor). The IRS auditor will send you a letter cordially inviting you to a local IRS office to speak about a specific issue on your tax return. Typically, office audits involve issues related to Schedule A (itemized deductions), Schedule C (business profit and loss), or Schedule E (rental income and expenses). The auditor will ask you to bring in specific documentation related to their inquiry. Office audits usually start off limited in nature, but can expand in scope, so it is important to make sure you don’t give away too much information. It is advisable to meet with a tax professional before an office audit.
Field Audit – A field audit is the most invasive and detailed type of audit the IRS uses. This type of audit is used almost exclusively for corporations and businesses. In a field audit, an IRS Revenue Agent (the most highly trained IRS auditor) will actually come to your place of business. The Revenue Agent will review certain financial/accounting documentation, interview employees, and tour the business facilities. They will want to know about the key operations of the business – including management structure, internal controls, and accounting procedures. This type of audit can be very disruptive – especially for small businesses – so it is advisable to hire representation to protect your interests in a field audit.