The Internal Revenue Service (IRS) audits a wide range of taxpayers, including individuals, small businesses, large corporations, partnerships, and nonprofit organizations. Individuals may be selected for audit due to discrepancies in reported income, unusually high deductions, or random selection. Businesses—regardless of size or industry—can be audited if their returns contain anomalies, significant cash transactions, or patterns that deviate from industry norms. High-income earners, self-employed individuals, and those with complex financial arrangements or international activities are often subject to greater scrutiny. While some audits are triggered by specific red flags, others result from computerized screening or information matching with third-party data.
An Internal Revenue Service examination—colloquially known as an “audit”—may take several procedural forms, each of which carries distinct practical considerations and possible financial consequences for the taxpayer. The most common and least intrusive is the correspondence audit, initiated when the IRS Automated Under‐Reporter or Error Resolution systems detect a discrepancy between information returns (for example, Forms W-2 or 1099) and the amounts reported on the taxpayer’s return.
In many cases, the IRS issues a CP2000 notice, which informs the taxpayer of the proposed changes resulting from the mismatch and requests supporting documentation or an explanation to substantiate the amounts reported on the return. The CP2000 notice typically asks for copies of pay statements, bank records, or other documents that clarify the discrepancy.
In turn, the IRS may request additional information and documentation in the form of an Information Document Request (IDR) issued on IRS Form 4564. If the taxpayer’s documentation satisfies the auditor, the case is closed with “no change,” meaning no additional tax, penalties, or interest. Should the IRS prevail in whole or in part, the Service will issue a notice proposing additional tax; interest under Internal Revenue Code § 6601 accrues from the original due date of the return until the liability is paid, and a 20 percent accuracy‐related penalty under § 6662(a) is ordinarily imposed where there is negligence, disregard of rules, or a substantial understatement of income tax.
An office audit, sometimes called a “desk audit,” typically involves a broader inquiry than a correspondence audit and requires the taxpayer (or representative holding a valid Form 2848 power of attorney) to appear at a local IRS office with books, records, and other corroborating evidence, often in response to one or more Information Document Requests (IDRs) issued on IRS Form 4564. The scope generally focuses on one or more discrete issues—such as Schedule C income, itemized deductions, or dependency exemptions—but can expand if the examiner identifies additional concerns. If the taxpayer supplies persuasive evidence, the audit may again conclude as a no-change. Where adjustments are agreed, the taxpayer and examiner execute Form 4549, Income Tax Examination Changes, reflecting the additional tax; any associated accuracy-related penalty may be reduced from 20 percent to 0 percent if the taxpayer demonstrates reasonable cause and acts in good faith under § 6664(c).
Failure to reach agreement prompts the issuance of a thirty-day letter conferring administrative appeal rights. Should the taxpayer decline or miss this window, the IRS will issue a statutory notice of deficiency (“ninety-day letter”), after which the matter can be contested in the U.S. Tax Court without prior payment or, alternatively, the tax may be paid and a refund suit filed in district court or the Court of Federal Claims.
Field audits are the most comprehensive and intrusive examinations, handled by revenue agents who visit the taxpayer’s home, business premises, or representative’s office. These audits often encompass multiple tax periods and complex issues such as inventory valuation, cost allocations, transfer pricing, or corporate reorganizations. Revenue agents typically issue one or more Information Document Requests (IDRs) using IRS Form 4564 to obtain detailed records and explanations from the taxpayer. The agent prepares a Revenue Agent Report detailing proposed adjustments. In addition to the standard § 6662 accuracy-related penalty, field audits can trigger heightened civil penalties: a 40 percent penalty for gross valuation misstatements or undisclosed foreign financial asset understatements under § 6662(h) and § 6662(j), respectively, or a 75 percent civil fraud penalty under § 6663 where the Service proves by clear and convincing evidence that underpayment was due to fraud. Interest compounds daily on both tax and penalties until full payment. Moreover, unresolved issues may be referred for criminal investigation if badges of fraud—such as falsified records, double sets of books, or willful concealment of income—are present.
A specialized, statistically driven procedure, the Taxpayer Compliance Measurement Program (TCMP) audit—currently morphed into the National Research Program—is designed primarily to refine IRS compliance models rather than to collect revenue. Nevertheless, taxpayers selected for these rare examinations must substantiate virtually every line item on the return. While the audit’s objective is research, any adjustments flow through normal deficiency procedures, attracting the same panoply of penalties and interest as other exams.
Across all audit types, three principal outcomes are possible: (1) no change; (2) agreed change, where the taxpayer signs the adjustment and arranges payment or an installment agreement; or (3) unagreed change, invoking administrative appeal or judicial review.
Throughout the audit process, the IRS may issue Information Document Requests (IDRs) on Form 4564 to formally request specific documents or information needed to substantiate items on the return. Penalties are mathematically calculated as a percentage of the underpayment determined after all concessions and credits. Interest, set quarterly under § 6621 at the federal short-term rate plus three percentage points for individual liabilities (and, in certain circumstances, an additional two points for large corporate underpayments), cannot be abated except in narrowly circumscribed situations such as IRS ministerial delay under § 6404(e). Consequently, proactive recordkeeping, timely response to IRS correspondence, and, when appropriate, early engagement of qualified tax counsel are paramount to minimizing both the substantive tax adjustment and the cumulative burden of penalties and interest.
Audits are typically initiated by the IRS through a variety of methods, including computerized screening, random selection, and information matching. The IRS may use statistical formulas to identify returns with anomalies or discrepancies, or it may select returns based on information received from third parties, such as employers or financial institutions. In some cases, audits are triggered by specific red flags, such as unusually high deductions or inconsistencies between reported income and information returns. Taxpayers are generally notified of an audit by mail; the IRS does not initiate audits by telephone or email.
If you are not satisfied with the results of an IRS examination, you have the right to appeal. You may request a review by the Internal Revenue Service Appeals Office, an independent organization within the IRS that resolves tax disputes without litigation. Alternatively, if you receive a statutory notice of deficiency, you may petition the United States Tax Court to contest the proposed adjustments before paying any additional tax. These appeal rights provide important opportunities to resolve disagreements with the IRS through administrative or judicial review.
Engaging a tax attorney can provide significant advantages throughout the audit and appeals process. A tax attorney brings specialized knowledge of tax law, procedural rules, and IRS practices, which can help ensure that your rights are protected and that you respond appropriately to IRS inquiries. Attorneys can communicate directly with the IRS on your behalf, prepare persuasive legal arguments, and negotiate settlements or payment arrangements. In cases involving complex issues, substantial liabilities, or potential criminal exposure, a tax attorney’s expertise is invaluable in minimizing risks and achieving the most favorable outcome possible. Reach out now to discuss your audit.