Types of Tax Audits

Types of Tax Audits: What Everyone Needs to Know

Understanding the various types of tax audits is crucial for small business owners, large enterprises, and taxpayers. Knowing the audit process and how to prepare can save you time, stress, and money. Our guide breaks down every tax audit type—from IRS audits to internal and external audits—to help you stay one step ahead.

Why Do Tax Audits Happen?

A “tax audit” might sound intimidating, but its purpose is straightforward. Audits are designed to ensure that taxpayers and businesses report financial information honestly, pay the correct taxes, and comply with the law. Sometimes audits result from simple discrepancies; other times, they are part of routine compliance reviews.

Tax audits vary in process, scope, and who conducts them. Understanding these differences is the first step toward peace of mind during tax season.

The Three Main Types of Audits

1. External Audits

An external audit is performed by certified public accountants (CPAs) who are not affiliated with your business. Their goal is to provide an unbiased opinion about your financial statements.

Key Characteristics: 

• Independence from the organization is essential. 
• Used to verify that financial statements meet accepted accounting standards. 
• Helps ensure regulatory compliance and increases credibility with lenders and investors.

A “clean” or unqualified opinion from an external auditor boosts your company’s reputation, makes your business more attractive to investors, and helps satisfy regulatory requirements.

2. Internal Audits

Internal audits are conducted by a company’s own audit staff or internal auditors. Rather than focusing on financial reporting for outsiders, internal audits aim to improve the business’s processes and controls.

Key Characteristics: 

• Focused on risk management, policy compliance, and operational efficiency. 
• Performed by employees or in-house audit teams. 
• Often identify weaknesses before they become larger issues.

They help business owners catch issues early, improve performance, and reduce the risk of fraud or costly mistakes. For small business owners, this proactive step is often overlooked until a problem surfaces.

3. Tax (IRS) Audits

A tax audit is an examination of a taxpayer’s or business’s tax return by the IRS (Internal Revenue Service) or state tax authorities. The purpose? To verify the accuracy of reported income, deductions, and credits.

Key Characteristics: 

• Initiated by government agencies to ensure tax compliance. 
• Typically prompted by discrepancies, unusual deductions, or random selection. 
• May be conducted by correspondence, in-office meetings, or on-site visits.

The IRS uses statistical methods and data-driven tools to spot anomalies in tax returns. Even minor irregularities may prompt an audit.

IRS Audits Explained

The IRS employs several types of audits to review tax returns. Understanding the differences will help you know what to expect and how to respond.

1. Correspondence Audit

This is the most common and least disruptive form of IRS audit.

• Conducted entirely by mail 
• Usually addresses simple issues or minor discrepancies 
• The IRS will request additional documentation (like receipts or forms) to clarify an item on your return 
• If you respond adequately, the matter can be closed quickly

The IRS notices that you claimed a large charitable deduction but didn’t include paperwork. You’ll receive a letter requesting proof. Provide the documentation, and you may not hear from the IRS again.

2. Office Audit

This audit takes place at a local IRS office.

• You’ll meet with an IRS officer in person 
• The IRS may ask questions about sources of income, deductions, or specific transactions 
• You’ll need to bring supporting documentation

If you claimed several complex business deductions, the IRS representative might want to review invoices, receipts, and bank statements. The interview is focused on verifying the accuracy of your return.

3. Field Audit

Field audits are the most comprehensive and typically involve a visit to your home, business, or accountant’s office.

• The IRS reviews your full financial records onsite 
• These audits can be detailed and wide in scope 
• Often used for larger or more complex businesses 
• May require several days to complete

A small business flagged for significant revenue fluctuations may be visited by IRS auditors, who review everything from payroll records to inventory lists.

4. Taxpayer Compliance Measurement Program (TCMP) Audit

TCMP audits are rare and thorough.

• IRS examines every line of your tax return 
• You must provide receipts, invoices, contracts, and bank statements for every entry 
• Used to measure overall tax compliance, not just to verify your return

A TCMP audit is time-consuming and exhaustive, but it helps the IRS refine its detection systems for the future.

What Triggers an IRS Audit?

Understanding why returns are selected for audit can help you avoid red flags:

• Discrepancies or mismatches in reported income vs. employer statements
• Large deductions that are unusual for your income level or industry
• Random selection, as part of the IRS’s ongoing efforts to ensure compliance
• Statistical anomalies detected by IRS computer systems

What Should You Do If You Face a Tax Audit?

1. Stay Calm and Get Organized: Audits are much more manageable when your financial records are in order. Gather receipts, invoices, bank statements, payroll reports, and relevant business documents. Make copies for the auditor.
2. Review the Audit Letter Carefully: Understand exactly what the IRS is questioning or requesting. Don’t provide more information than necessary, but always address their specific concerns directly and clearly.
3. Respond Promptly: Whether it’s a correspondence or an in-person audit, timeliness matters. Delays can create additional stress and potential penalties.
4. Consider Professional Help: Tax professionals can ensure you’re fully prepared, communicate with IRS agents on your behalf, and protect your rights through the process.

How Can Professionals Help with Tax Audits?

Mid-Atlantic Law & Tax offers:

• Comprehensive tax preparation and planning
• Representation during IRS audits or disputes with tax authorities
• Resolution of outstanding tax issues
• Guidance with international tax for businesses expanding overseas

Having legal guidance can mean the difference between a quick resolution and a drawn-out, costly process.

When It’s Time to Seek Help With Your Audit

Tax audits can be complex and intimidating, but they’re manageable with proper preparation and the right support. Whether you’re dealing with a simple mail-in request or a full-blown IRS field audit, understanding each type of audit and knowing how to respond effectively can save time, money, and stress. If you find yourself overwhelmed or unsure, don’t hesitate to seek experienced tax support. 

Mid-Atlantic Law & Tax focuses on supporting small business owners through comprehensive audits, tax planning, and compliance. Contact us today to schedule a consultation and approach tax season with confidence.

James A. Kraehenbuehl

James A. Kraehenbuehl, founder of Mid-Atlantic Law and Tax, is an experienced business attorney, tax lawyer, and executive who has represented hundreds of clients, from individuals with simple tax preparation to global companies with complex legal issues.

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