Due to the Internal Revenue Service’s shrinking resources (coupled with the possibility of future budget cuts), audits of individual tax returns fell to a 10-year low of just 0.7%. In addition to directing more and more of their everyday questions and functions (such as paying your taxes) to their website (www.irs.gov), the IRS will be relying more on “Correspondence Examinations (or audits).”
Basically an “audit by mail,” they are more efficient and automated than the standard office audit AND consume far fewer IRS resources. That being said, we may expect the individual audit rates to increase, especially after they’ve implemented the “Taxpayer Digital Communications” pilot program, which will further automate the audit process (still in the infant stages).
Items usually selected for Correspondence Exams are usually the Earned Income Tax Credit, Schedule A, C, E, F and Form 2106 (Employee Business Expenses). I hate repeating myself, but again, the IRS will NEVER initiate contact by phone– only by mail!
How does the IRS analyze returns for a potential audit? 1) Results of prior audits (i.e., are you making the same errors you did before?); 2) Third party information returns (W-2, 1099s, etc.) don’t match with your return; 3) Certain entries on the return “pop” by being too high/low and then require substantiation.
Correspondence audits are generally far less extensive than office or field audits and usually just focus on specific items on your return, like substantiating employee business expenses, providing documentation for charitable contributions, providing backup for the vehicle expense deduction, or providing school records for the education credit. Most of the time, it’s just a matter of mailing or faxing (but NOT both!) the required backup.
So, what should you do if you receive an IRS notice by mail? My first piece of advice is DO NOT THROW IT AWAY! Ignoring it will only make the problem worse. Let your tax professional know about the notice, and he/she will either handle it for you or tell you what to do. The most important tip from IRS auditors? Respond to these notices in a timely manner! Usually they require a response within 30 days of the notice, but you can always request additional time to put together your response (very easy to do so). Also, if you’re going to mail the requested documentation, NEVER mail originals– always mail photocopies.