When it comes to IRS audits, one of the most common questions taxpayers ask is, “How far back can the IRS audit you?” Understanding the statute of limitations, the various triggers for IRS audits, and the detailed process involved can help taxpayers prepare and avoid potential issues. This comprehensive guide will explore these aspects in detail.
What Is an IRS Audit?
An IRS audit is an examination of an individual’s or business’s tax return to verify that financial information is reported correctly according to the tax laws and to ensure the amount of income and expenses reported are accurate.
Types of IRS Audits
- Correspondence Audits: These are conducted via mail and are typically less complex.
- Office Audits: Conducted at an IRS office, these audits require the taxpayer to provide additional documentation.
- Field Audits: The most comprehensive type, where an IRS agent visits the taxpayer’s home or business.
- Taxpayer Compliance Measurement Program (TCMP): Used primarily for statistical purposes.
How Far Back Can the IRS Audit You?
Typically, the IRS audits the past 3 years of tax returns, but if significant errors or issues are found, they may extend the audit period to up to 6 years. Audits usually focus on returns filed in the last 2 years.
For taxpayers and small business owners concerned about how far the IRS can investigate, it largely depends on your specific situation. Exceptions to the 3-year rule include a 6-year audit period for major errors, such as underreporting income, and no time limit for unfiled or fraudulent returns due to criminal activities like tax evasion and fraud.
If you’ve made an honest mistake on your tax return, don’t worry. Follow the IRS’s guidance, provide the requested information, and they will help you navigate the process.
Statute of Limitations on IRS Audits
The statute of limitations sets a specific timeframe within which the IRS can review, assess, and resolve tax issues. After this period, they can no longer assess additional taxes, collect more money, or permit you to claim a refund. Generally, this period is 3 years from the date your tax return is due or filed, whichever comes later.
The 3-year timeframe starts after any granted extensions or if the return was filed late. This timeframe is known as the Assessment Statute Expiration Date (ASED).
If you do not file your tax returns, the statute of limitations does not start, allowing the IRS to potentially audit your returns indefinitely.
You can request to extend the statute of limitations, which might provide additional time to submit necessary documents and give the IRS more time to process your case. If you choose not to extend it, the auditor will make a decision based on the information currently available.
IRS Audit Triggers
Common Triggers
- Unreported Income: Failing to report all sources of income can trigger an audit.
- Excessive Deductions: Claiming unusually high deductions compared to income levels.
- Home Office Deduction: Misuse or excessive claims.
- EITC Claims: Incorrect claims for the earned income tax credit.
- Self Employed Taxpayers: High scrutiny due to potential for unreported income and expenses.
- Business Meals: Excessive or unjustified claims.
- Personal Vehicle: Incorrectly claimed business use.
Higher Than Average Rates
Taxpayers with higher than average rates of income or deductions in certain categories may attract IRS attention.
Specific Red Flags
- Math Errors: Simple mistakes can prompt an audit notice.
- Amended Return: Filing an amended return can sometimes lead to an audit.
- Foreign Income: Reporting foreign income incorrectly or not at all.
How Does the IRS Determine Who to Audit?
According to the IRS, audits are often initiated through a random selection process where a computerized system analyzes your return against the “norms” for similar returns. For instance, a freelancer earning $100,000 might typically report $5,000 in travel expenses. However, if you claim $50,000 in travel costs, which is significantly higher than average, the IRS would likely flag your return as an outlier, explained Mark Jaeger, vice president of tax operations at TaxAct.
Another reason for an audit is if the information on your return is connected to someone else who is being audited, such as a business partner or investor.
The IRS Audit Process
1. Initial Contact
The IRS will contact you via mail. Be cautious of audit notice scams that come through email or phone.
2. Providing Documentation
The IRS will specify the information requested. It’s crucial to keep detailed tax records and receipts for at least seven years.
3. Types of Documentation
- Tax Returns: Previous tax returns filed.
- Income Records: W-2s, 1099s, etc.
- Expense Records: Receipts, invoices, etc.
4. The Audit Examination
The audit can be a face-to-face audit or conducted via correspondence. The type of audit depends on the complexity of the tax matter.
5. The Examination Report
After the audit results are reviewed, the IRS agent will provide an examination report detailing any changes to the tax return.
What Happens After an Audit?
Audit Results
- No Change: The IRS accepts the tax return as filed.
- Agreed: The taxpayer agrees with the changes proposed by the IRS.
- Disagreed: The taxpayer does not agree with the changes, leading to potential appeals or even tax court.
Appeals and Tax Court
If you disagree with the audit findings, you can request a meeting with an IRS manager or appeal to the tax court.
Paying Additional Taxes
If the audit determines that you owe additional tax, you will need to pay the assessed tax, including any penalties and interest.
Tips to Avoid an IRS Audit
Accurate Reporting: Ensure all income is reported correctly and all deductions are legitimate.
Keep Detailed Records: Maintain thorough tax records to support your tax return.
Seek Professional Help: Consider hiring a tax professional to assist with preparing your tax returns and provide guidance if audited.
Understand Common Triggers: Be aware of IRS audit triggers and ensure you do not inadvertently trigger an audit by claiming excessive deductions or making errors on your tax return.
Special Considerations for Small Business Owners
Higher Audit Risk
Small business owners often face higher scrutiny due to potential tax issues such as unreported income and excessive deductions.
Self-Employed Taxpayers
Self-employed taxpayers need to be especially diligent in keeping records of income and expenses.
Home Office Deduction
Claiming a home office deduction can be a red flag. Ensure you meet the specific requirements and keep detailed records.
Impact of Tax Law Changes
Recent Changes
Stay informed about recent tax laws changes that may affect your tax return and potential for audit.
Foreign Income and Tax Treaties
Understand the implications of reporting foreign income and the impact of international tax treaties.
Conclusion
Understanding how far back the IRS can audit you and the various triggers for an IRS audit is crucial for both individuals and businesses. By maintaining accurate records, understanding common audit triggers, and seeking professional help when needed, you can minimize your risk of being audited and ensure compliance with tax laws. Always be prepared, as the IRS has the authority to review your tax returns and assess additional tax if necessary, helping you stay on the right side of the law.
