IRS Audit FAQ

The IRS uses a sophisticated computer screening system called the Discriminant Information Function (DIF) to identify returns with the highest probability of error. This algorithm assigns scores to tax returns based on statistical norms for similar taxpayers, flagging those with unusual characteristics for potential examination. Common audit triggers include: unusually high deductions relative to income, business losses year after year (hobby loss concerns), large charitable deductions exceeding income percentages, home office deductions, math errors and inconsistencies, failure to report all taxable income (mismatched 1099s or W-2s), round numbers suggesting estimation rather than actual recordkeeping, cash-intensive businesses, and significant changes from prior year returns without clear explanation.

The IRS also conducts random audits under the National Research Program to update DIF scoring models. Additionally, related party transactions, international accounts, and high-income returns (over $200,000) face increased scrutiny. If you're involved in a transaction with someone under audit, you may be selected for examination of that specific transaction. Tax shelters, cryptocurrency transactions, and certain industries known for compliance issues also receive heightened attention.

The IRS conducts three primary types of audits, each varying in scope and formality. Correspondence audits are the most common, accounting for approximately 75% of all examinations. These are conducted entirely by mail and typically focus on specific issues requiring documentation, such as substantiation of itemized deductions, education credits, or earned income tax credits. The IRS sends a letter requesting specific documents, which you mail back within the specified timeframe (usually 30 days). These audits are generally straightforward but still require careful attention to substantiation requirements.

Office audits require you to visit a local IRS office with specific documentation. These face-to-face examinations involve more complex issues than correspondence audits but are less extensive than field audits. An IRS examiner reviews your records in the office setting, asks questions, and may request additional documentation during or after the meeting. Field audits are the most comprehensive examinations, conducted at your home, business, or tax professional's office by a revenue agent. These audits involve extensive record review, often covering multiple tax years and complex business transactions. Field audits can last many months and may involve summons for third-party records under IRC Section 7602.

California taxpayers may also face parallel audits by the Franchise Tax Board (FTB) under California Revenue and Taxation Code Section 19504, which authorizes the FTB to examine returns and assess deficiencies. The FTB often initiates examinations after receiving information about federal adjustments.

Under the Taxpayer Bill of Rights codified in IRC Section 7803(a)(3) and expanded through various statutory provisions, you have comprehensive protections during an IRS examination. These fundamental rights include: (1) The right to be informed about what you need to do to comply with tax laws and about IRS decisions affecting your accounts; (2) The right to quality service, including professional and courteous treatment by IRS employees; (3) The right to pay no more than the correct amount of tax; (4) The right to challenge the IRS's position and be heard; (5) The right to appeal IRS decisions to an independent forum; (6) The right to finality, knowing when the IRS will conclude an examination; (7) The right to privacy and confidentiality regarding tax information; (8) The right to retain representation; (9) The right to a fair and just tax system.

Specific procedural rights include the right to record audit meetings with 10 days' advance notice under IRC Section 7521(a)(1), the right to receive Publication 1 (Your Rights as a Taxpayer) at the audit's beginning, the right to speak with a supervisor about inadequate service, and the right to propose installment agreements if you cannot pay assessed amounts in full. You also have the right to request that examinations be conducted at reasonable times and places. If you disagree with examination results, you have the right to appeal to the Independent Office of Appeals before any collection action begins.

Hiring professional representation is strongly advisable for most audits beyond simple correspondence matters requesting basic documentation. Under IRC Section 7525, communications with federally authorized tax practitioners—attorneys, certified public accountants (CPAs), and enrolled agents—may be privileged in tax matters to the same extent as attorney-client privilege. This protection applies in noncriminal tax proceedings before the IRS and in federal court. Representatives who practice before the IRS under Circular 230 understand examination procedures, administrative appeal processes, and negotiation strategies that individual taxpayers typically lack.

Professional representatives can communicate directly with the IRS on your behalf, preventing you from volunteering unnecessary information or making statements that could expand the audit scope. They ensure you don't inadvertently waive important rights, such as the statute of limitations, by signing extension agreements without understanding the implications. Representatives can also identify opportunities for favorable adjustments you might miss. For business audits, field examinations, or cases involving potential fraud indicators, professional representation becomes essential. The cost of representation—which may itself be deductible as a tax preparation expense under IRC Section 212—is often justified by the tax savings achieved and penalties avoided.

For California state audits running parallel to federal examinations, experienced representation becomes even more critical as you're defending on two fronts simultaneously, each with different conformity rules and substantiation requirements.

Audit duration varies significantly based on the examination type, complexity of issues, number of years under examination, and your responsiveness to information requests. Simple correspondence audits requesting documentation for specific items may conclude in 3-6 months with prompt document submission and clear substantiation. However, if the IRS requests additional information or questions your documentation, correspondence audits can extend 6-12 months or longer. Office audits typically take 3-9 months from initial notification to final determination, depending on scheduling availability, the number of issues examined, and whether the auditor requests supplemental documentation.

Complex field audits can extend 12-24 months or longer, especially for businesses with multiple years under examination, international transactions, or intricate tax issues. Large business audits of corporations may continue for several years. Under IRC Section 6501, the IRS generally must complete audits and assess any additional tax within three years from the return's filing date (or due date if later). However, this statute of limitations can be extended by mutual agreement using Form 872 (Consent to Extend the Time to Assess Tax). The IRS frequently requests such extensions to complete complex examinations, and while you can refuse, doing so may prompt the IRS to make determinations based on available information, potentially resulting in larger proposed deficiencies.

The statute extends automatically to six years under IRC Section 6501(e) if you omitted gross income exceeding 25% of the gross income shown on your return. For fraudulent returns or failure to file, there is no statute of limitations under IRC Section 6501(c).

If you disagree with audit findings, you have multiple levels of administrative appeal and judicial review available. First, you should discuss disputed issues with the examining agent and request an immediate meeting with the auditor's supervisor to explain your position. Many disputes resolve at this level through clarification of facts or law. If the disagreement persists, the examiner will issue a Revenue Agent's Report (RAR) or Examination Report detailing proposed adjustments. You then have 30 days from receiving this report to file a written protest requesting review by the IRS Independent Office of Appeals, as outlined in IRS Publication 5.

The Appeals Office provides an informal forum to settle tax disputes without litigation. Appeals officers are independent from the examination division and have authority to consider the hazards of litigation in reaching settlements. Most cases resolve at Appeals through negotiation. If Appeals doesn't resolve the matter satisfactorily, you'll receive a statutory Notice of Deficiency (also called a "90-day letter") under IRC Section 6212. This notice gives you 90 days (150 days if addressed to someone outside the United States) to petition the United States Tax Court for redetermination. Tax Court allows you to dispute the deficiency before paying any tax.

Alternatively, you can pay the disputed amount and sue for refund in federal district court or the United States Court of Federal Claims under IRC Section 7422. Each forum has different procedural rules, jurisdictional requirements, and strategic advantages depending on your case's specific circumstances.

Generally, the IRS has internal policies limiting repeat examinations of the same issues under the repetitive audit procedures outlined in IRM 4.10.1.3.2. If the IRS audited your return for the same items in either of the two previous years and proposed no change to your tax liability, the IRS will generally not re-examine those items. This policy prevents harassment through repeated examinations of identical issues already determined to be properly reported. If you receive an audit notice for items previously examined with no change, you should immediately contact the IRS, reference the prior audit, and request that the current examination be discontinued under the repetitive audit procedures.

However, this protection is not absolute and has important limitations. The IRS can conduct a second audit of the same tax year if substantial new information comes to light suggesting additional unreported income or fraudulent deductions, if the prior audit was limited in scope and didn't examine the items now under review, or if there are indications of fraud under IRC Section 6501(c)(1), which has no statute of limitations. The agency must document compelling reasons for repeat examinations to satisfy internal review requirements. Additionally, repeat audits may occur when examining related party transactions that weren't previously scrutinized or when information document matching identifies unreported income not addressed in the prior examination.

You have the right to request supervisory review of any decision to re-audit the same issues, and such review should consider whether the examination serves a legitimate compliance purpose rather than constituting harassment prohibited by IRC Section 7433.

Comprehensive recordkeeping is your best audit defense and legal obligation. Under IRC Section 6001 and Treasury Regulation Section 1.6001-1, taxpayers must keep books and records sufficient to establish the amounts and sources of income, deductions, credits, and other items affecting tax liability. The IRS doesn't prescribe specific recordkeeping systems, but your records must be permanent, accurate, and complete. Essential documentation includes: all bank statements showing deposits and withdrawals (to verify reported income and claimed deductions), receipts and invoices for deductible expenses, credit card statements supporting business charges, canceled checks, mileage logs for vehicle deductions showing date, destination, business purpose, and miles driven, and home office documentation including square footage calculations, photos, and expense allocation worksheets.

For business expenses, maintain contemporaneous logs with dates, amounts, and detailed business purposes. Entertainment and meal expenses require especially detailed substantiation under IRC Section 274(d), including the business relationship of persons entertained and specific business discussed. Investment records should document purchase dates, costs, sales proceeds, and basis adjustments for accurate capital gain reporting. Charitable contribution substantiation is particularly strict: you need written acknowledgments from qualified organizations for donations exceeding $250 under IRC Section 170(f)(8), and qualified appraisals for non-cash contributions over $5,000 under IRC Section 170(f)(11). Form 1099s, W-2s, 1098s, and other information returns must be retained to reconcile with reported income. Property records should establish cost basis, improvements, and depreciation schedules.

You should generally maintain tax records for at least three years from the filing date (matching the basic audit statute of limitations), though six years is advisable for substantial understatement situations, and indefinitely for property records establishing basis. California Revenue and Taxation Code Section 19504 imposes similar recordkeeping requirements for state tax purposes.

An IRS audit can result in three primary outcomes, each with different implications for your tax liability. A "no change" result means the IRS accepts your return as filed, resulting in no additional tax owed and no refund. This favorable outcome occurs when you provide adequate documentation supporting all reported items and the examiner concludes that income, deductions, and credits were properly reported under applicable law. Approximately 10-15% of audits result in no change, though percentages vary by audit type and issues examined. You'll receive a letter confirming the examination's closure and generally won't face additional questions about those items for that tax year.

An "agreed" outcome means you accept the IRS's proposed changes after reviewing the examination report. This results in additional tax owed, plus interest under IRC Section 6601 calculated from the original return's due date, compounding daily at the federal short-term rate plus three percentage points. You may also face accuracy-related penalties under IRC Section 6662, including 20% of the underpayment for substantial understatement (tax shown on return is less than the lesser of 10% of correct tax or $5,000), negligence or disregard of rules and regulations, or substantial valuation misstatements. In cases involving intentional wrongdoing, civil fraud penalties under IRC Section 6663 can reach 75% of the underpayment attributable to fraud. By agreeing, you waive appeal rights regarding those issues and must pay the amounts due or arrange installment agreements.

A "disagreed" outcome means you dispute the findings and pursue administrative appeals or litigation as previously described. The audit remains open pending resolution through these channels. Importantly, the IRS may also make favorable adjustments during examination, reducing your tax liability if the audit uncovers overpayments, missed deductions, or misapplied credits, though such outcomes are relatively rare.

California's Franchise Tax Board (FTB) often conducts examinations parallel to or following IRS audits, though each agency operates independently with its own examination authority, procedures, and legal standards. Under California Revenue and Taxation Code Section 18622, the FTB must follow federal determinations for items of income, deduction, and credit that are the same for federal and state purposes. However, California has numerous conformity exceptions where state law differs from federal law, including different treatment of certain business deductions, capital gain exclusions, and tax credits. In these areas, the FTB conducts independent analysis even when the IRS has made determinations.

The FTB receives information about federal audits through IRS-FTB information sharing agreements authorized by IRC Section 6103(d). When the IRS adjusts your federal return, you have a mandatory reporting obligation to the FTB. Specifically, if a federal change affects your California tax liability, you must report the changes to the FTB within six months using Form 540-X (Amended Individual Income Tax Return) under Revenue and Taxation Code Section 18622. Failure to report federal changes can result in California penalties of 25% of the additional state tax due, plus interest from the original due date. The FTB may also learn of federal adjustments directly from the IRS and initiate its own examination based on that information.

The FTB has its own four-year statute of limitations under Revenue and Taxation Code Section 19057, which can extend to eight years for substantial understatements exceeding $1 million under Section 19059. California examinations follow procedures similar to federal audits, with taxpayer rights protected under the California Taxpayer Bill of Rights (Revenue and Taxation Code Section 21003) and administrative appeal procedures outlined in Section 19041.

Yes, IRS penalties are often negotiable through several administrative relief mechanisms, and you should always explore penalty abatement options before accepting assessed penalties. First-time penalty abatement (FTA) is available under IRM 20.1.1.3.3 if you have a clean compliance history for the previous three years (no penalties assessed), filed all required returns, and paid or arranged to pay any tax due. FTA applies to failure-to-file, failure-to-pay, and failure-to-deposit penalties, though not to accuracy-related penalties under IRC Section 6662. FTA can be requested by phone, in writing, or through your tax professional, and the IRS typically grants it without extensive documentation when you meet the criteria.

You can request reasonable cause abatement under IRC Section 6664(c) and Treasury Regulation Section 1.6664-4 for any penalty if you can demonstrate that failure to comply resulted from circumstances beyond your control despite exercising ordinary business care and prudence. Acceptable reasonable cause includes death or serious illness of the taxpayer or immediate family, unavoidable absence, destruction of records by fire or other casualty, inability to obtain records, ignorance of the law if reasonable, reliance on incorrect advice from a competent tax professional, or IRS error. The key is showing that you acted responsibly before and after the circumstances that caused noncompliance.

Written statements, medical records, correspondence demonstrating advice reliance, and other documentation supporting reasonable cause significantly strengthen your abatement request. For California audits, similar penalty relief exists under Revenue and Taxation Code Section 19132, allowing the FTB to abate penalties for reasonable cause. Penalty abatement should be requested in writing with detailed explanation of the circumstances, supporting documentation, and citation to the applicable law or policy. You can appeal denied requests through the normal administrative appeals process.