Let's get real about "unreal" audits!

February, 01 2018 by Selena Quintanilla, CTEC

For a long time, it's been a general perception - and even a generally accepted fact - that only about 1% of tax returns are selected for review annually by the IRS. Thanks to The National Taxpayer Advocate (NTPA), we now know that the number of taxpayers who hear from the IRS is more along the lines of 6.3%. Though this may not seem like a significant gap in percentages, over 9.1 million taxpayers were contacted by the IRS in 2016 and asked to verify information on their returns. Of the 9.1 million returns evaluated, the IRS only considered 1 million to be under "examination" and classified officially as audits.

The three types of traditional examinations conducted by the IRS are correspondence, field, and office audits. Communication that doesn't fit into these categories are not reported as audits by the IRS and are referred to by the NTPA as "unreal" audits.

What is an "unreal" audit?

An "unreal" or untraditional audit refers to specific compliance-related notices issued by the IRS. The trigger for these contacts is usually a difference between what a taxpayer reported on their return and what was reported to the IRS by a third party. Math or clerical error, underreporting of information, suspected fraud or identity theft, and failure to file are the main reasons behind these contacts.

Sounds like an audit, doesn't it? And to the taxpayer on the receiving end of a notice, it certainly feels like an audit. That's the problem.

"Unreal audits" often require the same verification principles as traditional audits and incite the same level of discomfort as a real examination. "Unreal" audits regularly lead to further inquiries and even examinations without changes to the classification. Perhaps the most crucial difference is that based upon how the IRS categorizes these contacts, the taxpayer's rights are dramatically affected.

In a traditional audit, the taxpayer can seek administrative review with Appeals before receiving a notice of deficiency, exercising the taxpayer's right to be heard; this right is non-existent in "unreal" audits. In "unreal" audits, refunds are subject to hold without sufficient information or contact from the IRS for weeks or months. Additionally, communications regarding math errors require a request for abatement be received within 60 days, or the IRS may impose the tax without turning to deficiency procedures.

Likely the most unsettling revelation lies in the fact that the IRS plans to increase the use of these compliance contacts, meaning that "unreal" audits can become a real problem for more taxpayers. And the fact that these types of notices are disproportionately received by low and middle-income taxpayers means that more people will be affected who are unable to afford representation.

The IRS's history of narrowly defining "examination" has given rise to a false sense of security about audits. Until the agency gets real about "unreal" audits, it will be our responsibility as taxpayers to be aware that we have different and sometimes limited rights depending on the type of letter we receive - and to understand what our actual rights are in the event we need to exercise them.