The IRS examination process is the method by which the IRS examines tax returns. Examinations may be directed at individuals, businesses, partnerships, trusts, estates and any other person subject to US taxation.
The IRS scientifically determines which taxpayers to examine by using a variety of time-tested methods aimed at maximizing the collection potential available and minimizing the time necessary to perform such examinations (see also Audit Selection). Certain examinations are chosen randomly, but for the most part, the IRS is specifically targeting certain taxpayers based on information gathered from others. Most recently, the IRS has shown great success and is developing partnerships in gathering this information. As information has become more readily available, the IRS has increased its examination base significantly in recent years. We can anticipate that the number and scope of audits will increase going forward.
The IRS examination process generally begins with the identification of probable reporting errors. Most IRS examinations involve correspondence audits; one in which a letter of proposed adjustment is simply sent to the taxpayer or one in which additional information is needed.
The more invasive audit is a field audit or office visit; in which the taxpayer is examined in a face-to-face meeting with an IRS examiner looking to collect money. Taxpayers are usually notified by mail but may alternatively receive a visit from their local agent without notice.
IRS examiners are skillfully trained in gathering information quickly to determine the potential that may exist for errors, unreported income, misapplication of tax law, etc. that may result in increased collections.
IRS examiners are directed to follow a series of steps required in the examination process as outlined in the Internal Revenue Manual. The examination process procedures usually require a high degree of knowledge, training and experience to be successfully and efficiently performed. Newer agents are assigned examinations with a lower level of difficulty for training purposes, whereas identified taxpayers with more complex issues and the collection potential for greater dollar amounts are assigned to the more experienced examiners.
Taxpayers are required to maintain records in support of their tax returns throughout the examination period. Most examination periods are generally 3 years, but other exceptions may apply. Taxpayers are not always required to maintain records where alternate methods of calculating deductions are available.
The examination process will include a detailed examination of the most significant areas of tax return deductions – those where the probability of misreporting and dollars at risk are high.
IRS examinations also consider the underreporting or omission of income. The IRS will often compare deductions reported by other with income reported by the taxpayer for completeness and accuracy. They will often gather taxpayer bank account statements and compare gross receipts to the income that’s reported. In certain circumstances, the IRS will look at the lifestyle of the taxpayer comparative to taxable income reported.
Through a series of meetings with the taxpayer or taxpayer’s representative, the IRS will make a determination of taxes that may be owed and present a proposed adjustment. Taxpayers not agreeing with the findings have certain limited rights of appeal within the IRS or through courts of law. Taxpayers not exercising these rights, or allowing these rights to lapse, may be faced with the inability not to be held responsible and the payment of these taxes.