What Is a Pre-Audit?

Although the very thought of an IRS audit may strike fear and trembling into even the most compliant of taxpayers, there’s actually a nice surprise waiting at the end of many audits. Of the tax returns filed in 2016 alone, 34,000 taxpayers received additional refunds after their audits were completed – to the collective tune of a whopping $6 billion. And even though this may not relieve your anxiety at the prospect of your tax returns being audited, consider another statistic. The IRS audited only 0.5 percent of the tax returns filed in 2016. If you find yourself in this tiny slice of taxpayers whose returns are selected for auditing, your experience may not progress to a full-blown audit if your auditor's initial questions or fact-checking are satisfied during the pre-audit process.

IRS Audit Selection Process

If your tax return is selected for a pre-audit or full audit, it doesn’t necessarily mean there’s a problem with your return. Some returns are chosen randomly, based on a computer-generated statistical formula. These returns are compared against IRS-developed "norms," which are other tax returns that contain similar information as yours. The IRS develops these norms through its National Research Program by analyzing data from statistically similar random tax returns. Another way a tax return may be selected for audit is when it has potential issues with similar taxpayers whose returns were chosen for audit, such as your business partner or an investor.

IRS Examinations

IRS audits are also called “examinations” because auditors, also called examiners, review the submitted information that taxpayers include on their tax returns. If an auditor finds something that requires further examination or clarification, the auditor forwards the tax return to a group of examiners for their review. If the examining group still has questions, the IRS notifies the taxpayer that the return is up for audit. Contrary to what some taxpayers believe, receiving a tax refund does not sound an alarm bell or wave a red flag to the IRS to trigger an audit.

What Is a Pre-Audit?

Whether a tax return is randomly selected or specifically earmarked for review because of potential issues with other taxpayers’ returns, pre-auditing is the first step that IRS examiners take. The first reviewing IRS agent examines the return for accuracy and makes sure any supporting documents are included (such as IRS-required forms or schedules). The pre-auditing process may stop here if everything meets muster according to the IRS-assigned examiner.

If your return warrants a second look, this is when the auditor may forward your return to the group of examiners for their review. But the auditor may simply send you a questionnaire to get more information about a possible area of concern. The questionnaire may ask for certain business records (if you own a business) or it may ask for bank records, canceled checks, divorce settlement papers or receipts to document some of your expenses. Resolution may be as simple as mailing or faxing the requested documents to the IRS without the audit progressing to an in-person appointment.

A Company's Self-Audit

Business owners typically are familiar with another type of audit, which may also have a pre-audit phase. Business audits are examinations of a company's internal processes, including its financial statements, which provide accountability to a board of directors and stockholders, maintain accuracy in reporting transactions and ensure compliance with tax laws. Company audits may be performed internally by its financial staff or externally by an independent auditor or team of auditors. The audits may also be a combination of both. For example, a company's pre-audit process may include having its in-house certified public accountant review financial statements for accuracy before submitting them to an external auditor for the full audit. Although company audits are not the same as IRS audits, they do serve a similar purpose in ensuring that the financial side of a business complies with tax laws. Unlike IRS audits, however, company audits are typically scheduled on a regular basis such as quarterly or yearly.

IRS-Initiated and -Conducted Audits

Whether the taxpayer is an individual or a business, the IRS will begin its audit process through the mail. It’s important to note that the IRS will never initiate an audit over the telephone. In certain circumstances, the IRS does call or visit a home or business, but these calls and visits are preceded by several letters through the mail, which are called “notices.” The initial contact to schedule an audit, however, is not included in these circumstances. It’s only if the IRS needs to schedule a site visit after conducting a pre-audit that it sends notices of this intent. IRS auditors present two credentials at their in-person appointments – a “pocket commission,” which is an official IRS identification, and an HSPD-12, which is an official identification for government employees and contractors.

Types of IRS Audits

If the IRS selects your tax return for audit and contacts you by mail, it will request one of two types of audits. The first type allows you to respond without meeting an auditor in a face-to-face examination because it's conducted through the mail. If you're selected for the second type, it means you'll have to schedule an in-person meeting with an auditor.

1. Mail audit – Also called a correspondence audit, the mail audit is more commonly performed than an in-person examination. Mail audits account for around 75 percent of all IRS audits, which is good news for taxpayers who prefer to respond from the comfort of their own homes or offices without an IRS agent present. It can be a standalone audit (meaning potential issues are resolved through the mail, ending the audit process) or it can be the pre-audit step to a more comprehensive in-person audit. The initial audit paperwork you receive from the IRS includes a request for additional documentation that you simply mail back to the IRS by the due date listed. This letter also includes contact information for your questions.
   
2. In-person audit – The mail audit is initiated and often completely resolved through correspondence only. The in-person audit will also be initiated by a preliminary letter, but it is conducted in person. This type of audit may be held at your home, your place of business, your attorney's or accountant's office or an IRS office. The IRS will let you know which part of your tax return requires further examination and what documents or other information you'll need to provide.

Your Response

Before you start white-knuckling your armchair at the discovery of an IRS notice of audit in your daily mail, know that you or your tax preparer may have simply forgotten to include an attachment that the IRS needs to process your return. Or you may have made a mathematical error that can quickly be corrected. If you're self-employed, the IRS may use one of its "Audit Technique Guides" in your review. These guides are industry-specific, and although they're designed to assist IRS auditors in their examinations, you can give yourself a heads-up by reading them online. Many businesses use these guides as a reference when preparing their tax returns. Visit IRS.gov and type "Audit Technique Guides" in the top right search block.

1. Mail audit – Look for a deadline in the letter, by which you'll need to provide more information or supporting documents for your tax return. Often, this deadline is 30 days away, so this gives you time to do your research. The IRS can propose changes to your tax return, which (on further inspection) you may realize are accurate. But even if you don't see an error, reply to the letter and submit your supporting documents. The IRS recommends sending copies to them and keeping your originals. If the instructions allow you to fax your documents, write or type your name and Social Security number on each page that you transmit. If you have a lot of documents to send via mail or fax, you can always request an in-person interview.
   

2. In-person audit – Your pre-audit letter will have all the instructions you need. You may first want to check the day and time that the IRS has scheduled for your audit. If this won't work well for you, contact the examiner well in advance of your appointment to discuss rescheduling the meeting.

   If you'd like for your attorney or accountant to be present at the meeting, check to make sure everyone's schedules align. Collect the required documentation and review everything carefully to make sure the error is not on your side. If you happen to find an error that you made, contacting the examiner may resolve the issue and stop the audit.

Pre-Audit Checklist

Although each audit is uniquely tailored to each taxpayer's tax return needs, the IRS offers some general guidelines that apply to most audits. Your pre-audit checklist may include some of the following items:

• Loan papers – If you claimed an interest deduction on qualifying loans, such as your mortgage, or if you own a business and have business loans, make sure your loan papers include all the pertinent details. Examples include the names of borrowers and lenders, the legal description and location of the property and the terms of the loan.
  
• Other legal papers – If you're divorced or legally separated, have these papers handy as well as any court-ordered alimony or child-support paperwork.
• Educational receipts – If you claimed any educational expenses for you or a qualifying dependent, keep information about the qualifying educational institution with your allowable, reimbursable receipts, which are dated.
• Medical records – For all nonreimbursed medical or dental expenses, keep your receipts as well as documentation for what diagnosis or treatment you received. 
• Forms 1099 – If you have income from sources other than wages, salaries or tips, have all applicable Form 1099s at your fingertips. For example, if you're an independent contractor, keep all the 1099s you received from your clients to support the income you received as well as document each client's name and address.
• Canceled checks – Keep copies of your canceled checks (or online banking statement if you have a paperless account) in addition to your receipts as substantiating paperwork for allowable deductions, including charitable contributions. 

If You Need More Time

You may run into a snag as you try to locate a specific document the IRS needs or put together a paper trail that supports the tax return information you submitted. If so, the IRS offers some time extensions depending on the type of audit they scheduled for you.

• Mail audit – Fax a written request to the IRS to the number provided in the letter you received. If you don't have access to a fax machine, you can also mail your request to the address noted in the letter. Typically, the IRS grants an automatic 30-day extension for taxpayers who request one. If you have a dispute, you have 90 days from the original letter to file a petition with a U.S. Tax Court.
  
• In-person audit – If you received a letter notifying you of an in-person audit, the IRS assigned a specific auditor to you. You can reach this auditor directly at the contact information in your letter to request an extension.