Understanding the Different Types of IRS Audits

With Tax Day just around the corner, now is a time of year when many people, particularly high-income and high-net-worth taxpayers, begin to have concerns about the possibility of facing an IRS audit. Even if you do your best to meet your federal tax obligations—and even if you rely on an accountant or tax preparer to file your returns for you—there is still a risk that you could face unwanted scrutiny from the IRS. With this in mind, here is a brief primer on IRS audits from Texas tax attorney Lawrence Brown.

3 Types of IRS Audits

The IRS currently conducts three types of audits to enforce taxpayer compliance and pursue collection of unpaid federal taxes (plus interest and penalties). These are (i) correspondence audits, (ii) office audits, and (iii) field audits.

1. Correspondence Audits

Correspondence audits are by far the most common type of IRS audit. These audits involve dealing with revenue agents remotely, with revenue agents typically requesting various forms of documentation in order to substantiate (or disprove) the numbers in taxpayers’ returns.

While some correspondence audits can be fairly straightforward, others can be both highly complex and high-risk. As a result, taxpayers need to be extremely careful when communicating with revenue agents during correspondence audits. This includes being extremely careful about the records they voluntarily share with the IRS. Voluntarily disclosing records that reveal inaccuracies in taxpayers’ returns can prove very costly, and while taxpayers ultimately need to comply with the Internal Revenue Code (IRC), there are better ways to deal with inaccuracies (or potential inaccuracies) than to simply disclose them during the audit process.

It is also important to note that just because an IRS audit begins remotely, this doesn’t necessarily mean that this is as far as the IRS is going to go. If revenue agents uncover evidence of apparent underreporting or underpayment, they may choose to dig deeper—potentially choosing to visit the taxpayer’s home or office. This can up the stakes significantly, and it is an escalation that should be avoided if at all possible.

2. Office Audits

Office audits involve meeting with revenue agents at the IRS’s offices. Although this meeting is styled as an “interview,” the purpose is to uncover any information that the IRS may be able to use to substantiate allegations of noncompliance. The IRS generally uses office audits in cases of suspected noncompliance and when a full-blown field audit does not appear to be necessary—at least initially. Some examples of common triggers of office audits include concerns related to:

• Itemized deductions (including charitable deductions and self-employed or small business expenses)
• Business profits and losses
• Rental income and expenses
• Gaming and gambling winnings and losses
• Cryptocurrency gains and losses

While one specific issue will often trigger an office audit, revenue agents may ask wide-ranging questions during the interview process. As a result, taxpayers who are facing office audits must ensure that they are thoroughly prepared for their interviews. This includes having a clear and comprehensive understanding of their current compliance status and the types of issues that have the potential to lead to additional scrutiny.  

If a taxpayer who receives notification of an impending office audit is aware of issues with their returns (or if they discover issues during their preparations), a proactive approach will almost always be best. In this scenario, it may make sense to have your Texas tax attorney reach out to the revenue agents who are handling your audit before your interview to discuss potential means of resolution that will minimize your federal liability.

3. Field Audits

During a field audit, revenue agents visit the taxpayer’s home or office to gather information that is relevant (or potentially relevant) to the taxpayer’s federal returns. These are invasive and high-risk inquiries, and taxpayers need to work closely with experienced tax counsel to ensure that they are thoroughly prepared.

For individual high-income and high-net-worth taxpayers, this means working with their tax counsel in advance of the audit to assess compliance and identify the documents that revenue agents will likely want to review. Businesses need to take these same steps in addition to ensuring that their personnel know what to do (and what not to do) during the field audit process.

Here, too, if revenue agents are likely to uncover issues during an audit, it will generally be best to address these issues proactively rather than taking a wait-and-see approach. As a result, promptly engaging experienced tax counsel is key. While some options go off of the table once an audit is underway, if you wait for revenue agents to discover a violation on their own, this could limit your options even further.

Facing Scrutiny from IRS CI: Audits vs. Investigations

In addition to using audits to enforce compliance with the Internal Revenue Code, the IRS also conducts investigations in cases involving potential criminal violations of the IRC and other federal statutes. If you are facing scrutiny from IRS Criminal Investigation (IRS CI), this is an extremely high-risk matter that requires your immediate and complete attention. Investigations can lead to serious federal charges, including charges that carry substantial fines and terms of imprisonment.

You will know that you are facing an investigation if you receive a target letter or other form of communication from an IRS CI Special Agent rather than an audit notice from a revenue agent with the IRS. However, all three forms of IRS audits can lead to IRS CI investigations as well. Ultimately, all types of IRS inquiries require prompt attention, and avoiding unnecessary consequences involves working closely with experienced tax counsel to ensure that you are making informed and strategic decisions.

Request a Confidential Consultation with Texas Tax Attorney Lawrence Brown

Texas tax attorney Lawrence Brown represents high-income and high-net-worth taxpayers who are facing scrutiny from the IRS and IRS CI. If you have received an audit notice (or any other form of communication from the IRS or IRS CI), we invite you to call 888-870-0025 or contact us online to request a confidential consultation.