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What is an audit?
An audit is an inspection of an individual's or entity's books and records by the IRS. If you're being audited, the IRS will send you a letter stating which type of audit applies to you.

There are 3 types of audits: a correspondence audit, a field audit or an office audit.
 

Correspondence Audit: You don't need to see an IRS agent for this type of audit. The IRS will request documentation, and you will be able to mail it to them instead of delivering it in yourself.
 

Field Audit: If the IRS needs to verify information about your home or business, they may come to see it. Field audits usually involve physical IRS Inspections, and generally would have to do with a business.
 

Office Audit: You must visit an IRS agent in their office and provide documentation based on what was requested.

You are responsible to keep all supporting tax documentation for 7 years in case of an audit.
 

Returns claiming the Earned Income Credit are more likely to be audited by the IRS.

Preparing for an Audit
Always be sure to provide everything the IRS asks for within the requested amount of time. If you're asked to appear before the IRS, you should bring along your tax return and all of the supporting documentation for the tax year being audited, along with any other documentation or items requested in your IRS letter. Never let the auditor keep any of your originals documents, always provide them with copies of everything requested.

According to the IRS annual data book, individual returns where taxpayers claimed the Earned Income Credit were high on the list to be audited, business owners filing a Schedule C are also increasingly being audited.

 

If the corrections in your IRS audit effects your state income tax return, you'll need to amend that return. California, for example, provides that the statute of limitations on the state return is waived if you have a Federal adjustment, unless you report that adjustment within 6 months of when it becomes final.

The IRS does not generally notify the State, unless there is a case involving fraud. The audit offices operate independently. Payments are made to each office, independent of the other. The same thing goes for refunds.

 

There are several ways to reduce the chances that your tax return will come under state tax audit. Those who work from home should remember that the Internal Revenue Service (IRS) tends to focus on home office deductions. People who qualify for home office deductions operate their offices as principal places of business that are in regular and exclusive use for business. In other words, a home office should be the place where you spend most of your time making the majority of your income.

To avoid a state tax audit,

Keep deductions at a reasonable level.

Retain receipts for all deductible expenses, including food, entertainment, travel, and auto costs. The IRS puts deductibles under high scrutiny.

Income should be consistent with the average income of others living in a particular locality.

The IRS also becomes interested when someone’s income is much lower than the previous year’s taxable income. This would indicate that the person is hiding money and may result in a state tax audit.

 

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